Waiting on the world to change

Another month of strong economic data in the United States has kept the FOMC in a holding pattern. Nonfarm payrolls increased by 303K in March, capping a strong first quarter in which monthly job growth averaged 276K per month. The unemployment rate remains low at 3.8%, and real GDP growth is tracking to be a respectable 2.0%-2.5% in Q1.

The inflation data also have come in stronger in recent months. The core CPI increased at a 4.5% annualized rate in the three months ending in March, the fastest pace since May 2023. Data for the Fed's preferred measure of inflation, the PCE deflator, are only available through February but also point to some stalling out in the descent back to 2% inflation.

Fed officials have taken note, and their communication with the public increasingly stresses that there is no sense of urgency when it comes to cutting rates. This sentiment can perhaps be best summarized by Governor Waller's recent speech titled “There's Still No Rush,” a reference to the increasingly common view that rate cuts will start later and proceed more slowly relative to expectations a few months ago.

In light of the recent data and Fed speak, we have pushed out the timing of the first rate cut in the anticipated easing cycle. In our view, the FOMC will keep rates steady through the summer as it awaits confirmation that inflation is on a durable path back to 2%.

We now expect the FOMC to cut the fed funds rate by 25 bps at its September 18 meeting, followed by 25 bps rate cuts at every other FOMC meeting through the end of next year. If realized, this would put the target range for the fed funds rate at 3.75%-4.00% at year-end 2025.

Our expectation for rate cuts starting in September and continuing through 2025 is predicated on the belief that inflation will continue to slow, albeit gradually. Despite recent bumps in the road, the core PCE deflator has risen "just" 2.8% over the past year, the smallest 12-month change since March 2021. Private sector measures of rent growth signal that there is more shelter disinflation to come in the months ahead. Supply and demand in the labor market has come into better balance as evidenced by labor costs that are inching closer to a growth rate that is consistent with the Fed's 2% inflation target.

In a recent speech, Chair Powell nodded to the recent run of hot data but expressed the belief that the data do not “materially change the overall picture, which continues to be one of solid growth, a strong but rebalancing labor market, and inflation moving down toward 2 percent on a sometimes bumpy path.” We broadly concur with this view, but the “sometimes bumpy path” likely means it will be several more months before the much-anticipated easing cycle can begin. Until then, the FOMC will keep on waiting on the world to change.

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