Fed: frontloading to secure a soft landing

The long-anticipated easing cycle in the US started with the Fed cutting by 50bps instead of the more traditional 25bps as we expected. However, Powell pushed back against the idea that 50bps will be the new 25bps, noting that the Fed is not in a rush to lower rates. Participants’ interest rate projections continue to show a soft landing and a gradual path of policy normalisation.

However, in our view, the September FOMC meeting signals an important dovish shift in the Fed’s reaction function. Chair Powell wants to be more pre-emptive in securing a soft landing and his tolerance for further softness in the labour market seems quite low. Therefore, even though Powell and the median interest rate projections are signaling a series of 25bps cuts in the months ahead, we suspect even a small increase in the unemployment rate could tip the balance to a more aggressive frontloading of rate cuts.

With today’s fed funds rate of 4.875% still significantly above the FOMC’s neutral estimate of 2.875%, we now expect another 50bps rate cut at the November meeting, followed by a 25bps cut in December.

We continue to see a total of 100bps of cuts in 2025 to 3.125%, but likely more front-loaded. Risk is tilted towards a faster return to the neutral rate. If there is a significant spike in the unemployment rate, the terminal rate would move well below the neutral rate.

We keep our ECB baseline scenario unchanged for a pause in October and a 25bp cut in December. Risks are tilted towards a larger move (50bp) in December. More importantly, the Fed’s determination and the acceleration of disinflation in the euro area will probably lead the ECB to dial back its restrictiveness more rapidly in 2025.