Wall Street expects further significant rate cuts, while Federal Reserve officials disagree!

Wall Street and the Federal Reserve have reached a consensus on the magnitude of the first 50bp rate cut, but there is still a significant difference between the two sides on the pace of future rate cuts.

Wall Street bets that the deterioration of the economy and labor market will force the Federal Reserve to accelerate the pace of rate cuts. The Federal Reserve, on the other hand, prefers to continue cutting rates at a slow and steady pace, citing reasons such as the continued strength of the U.S. economy, a balanced labor market, and ongoing inflation slowdown.

The CME FedWatch Tool shows that the probability of a 25bp and 50bp rate cut by the Federal Reserve in November is basically "fifty-fifty," and then there will be a further substantial rate cut in 2025.

The Battle Against Inflation! Is the Federal Reserve Close to Declaring Victory?

The Federal Reserve has a dual mandate to achieve full employment and price stability.

After a two-year battle against inflation, the U.S. inflation rate dropped to 2.5% in August, the lowest level since February 2021. Most officials believe that the Federal Reserve has made significant progress in balancing these two major goals.

Minneapolis Fed President Kashkari stated in an article on Monday that he supported the decision to cut rates by 50 basis points last week, as inflation has significantly cooled and is approaching the Fed's 2% target, while the labor market is beginning to show signs of weakness.

In my view, the risk balance has now shifted from rising inflation to rising unemployment.

Kashkari stated that policy remains tight, and he expects future rate cuts to be smaller, with two more 25 basis point cuts expected by the end of the year.

On the same day, Atlanta Fed President Bostic stated that the Federal Reserve has made "substantial progress" in fighting inflation, while risks in the labor market have increased but have not yet "flashed red lights."

Although inflation remains above the Fed's target, it is estimated that at the current pace, inflation will reach the Fed's target in the next year. Fed Governor Waller stated last week:

This makes me think (a 50bp rate cut) is the right thing to do.

Of course, not all Fed officials believe that the task of fighting inflation has been completed.

Fed Governor Bowman warned that inflation could rebound in the coming months, and she is more inclined to a 25bp rate cut in September, being the only dissenting voter for a 50bp rate cut at the September FOMC meeting.

Where is the end point of interest rates? It depends on inflation and employment

Federal Reserve Chairman Powell described the 50bp rate cut as a "re-calibration" of monetary policy at the press conference, rather than a panic measure to avoid an economic recession.

Of course, if there is no risk of economic recession in the United States, the Federal Reserve does not need to aggressively cut interest rates.

The Atlanta Fed's GDPNow model currently estimates a year-on-year GDP growth of 2.9% for the third quarter in the United States, indicating that the economy remains robust. In addition, the Fed's September forecast shows that by 2027, the real GDP growth rate in the United States will reach 2% per year, with the highest unemployment rate only at 4.4%.

However, there are signs of deterioration in the labor market. In August, the unemployment rate climbed from a 50-year low of 3.4% to 4.2%.

According to the dot plot released by the Federal Reserve in September, the Fed will cut interest rates by a total of 100bp this year (meaning there will be another 50bp cut later this year), and then cut another 100bp by the end of 2025, bringing the target rate to a range of 3.25%-3.5%.

There is still internal disagreement within the Federal Reserve on the neutral interest rate, but Bostic believes this is not important, he said:

At least in my view, that was the case in the September meeting. Regardless of where the neutral rate is, I don't know who would reasonably argue that rates are far above neutral.

Gurk and others believe that as the inflation rate continues to decline, the real (or inflation-adjusted) federal funds rate has risen, effectively making policy tighter.

Federal Reserve Governor Quarles said on Wednesday:

While future actions... will depend on the inflation, employment, and economic activity data we receive, if conditions continue to evolve as they have so far, further rate cuts would be appropriate.

Will there be another 50bp rate cut in November? Focus on the next two non-farm payroll reports

The next FOMC meeting will be held on November 6th to 7th, just a few days after the U.S. election. As usual, Fed officials have left enough room for the next steps.

Waller said that if the unemployment rate worsens and inflation continues to slow further, there may be another 50 basis point cut. On the other hand, if inflation rebounds, the Fed may pause the rate cuts.

The focus is now on the next two (September and October) non-farm payroll reports, especially the October report, which will be released during the blackout period before the FOMC policy meeting, making it crucial for the interest rate decision.

Matthew Luzzetti, Chief U.S. Economist at Deutsche Bank, wrote on Wednesday:

While overall data is always important, the upcoming labor market data will give the Fed more confidence that the softening trend in the labor market is stabilizing Luzzetti stated that if the unemployment rate exceeds the Federal Reserve's forecast of 4.4% and non-farm payroll employment remains around 100,000 per month or lower, there will definitely be another 50 basis points rate cut in November. Furthermore, a significant downward revision in employment numbers would also provide additional reasons to accelerate the pace of rate cuts