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  • Writer's pictureJonathan Wilmot

What is the Fed Saying?

After Wednesday's FOMC meeting, the Fed signaled that they expect to make 3 rate cuts by the end of this year, and another 3 next year.

Below we show two versions of a simple measure of "hawkishness", based on the sum of the inflation gap (how much inflation exceeds 2%) and an employment gap (positive when unemployment is below the CBO estimate of current NAIRU). One is based on the Core PCE 6m/6m annualised rate, the other is based on Core PCE Less Shelter, both calculated back to 1960.

Periods of Fed tightening (increasing Fed Funds rate) are shaded in pink, the idea being that the Fed "should" be raising rates when the index is above zero and rising or cutting rates when the index is below zero and falling. Obviously the Fed didn't have an explicit 2% inflation target - or even an implicit one - till the mid-1990s, but both measures do a pretty good job of signaling periods of Fed tightening from the past.

The first measure (not excluding shelter costs) suggests that it is still too early to cut, the second suggests they could cut start to cut rates now. But either way, their expectations for rate cuts in the next two years indicate quite a high degree of confidence that inflation will come back down to 2% and stay there. Moreover, median expectations from the SEP about the unemployment rate are for a very small increase - to 4% by end 2024 and to 4.1% by end 2025. (Their long projection is 4%, which could be taken as an indication that the Fed thinks that the NAIRU is now 4%).

Even assuming that overall core inflation comes back to target over the coming months the Fed is implying that were they not to cut rates this year and next that unemployment would rise rapidly (recession).


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