Macro
Fed's Dot Plot Could Lead to a Market Sell-Off
Fed's strategy hinges on job growth, market stability, and cautious rate adjustments to sustain economic momentum.
Key Takeaway
September Rate Cut ‘a coin flip’ As the Federal Reserve gears up for its two-day meeting, the financial world is abuzz with speculation and anticipation. The likelihood of a rate cut in September has become a focal point, with the CME FedWatch Tool a roughly 49% probability. However, Joe Brusuelas, Chief Economist at RSM, offers a nuanced perspective that underscores the complexity of the current economic landscape. “I think it's appropriate that a little bit of risk aversion has crept in to the federal funds market. And I think it really is right now, a coin flip on September,” Brusuelas said. "The US economy continues to outperform expectations," Brusuelas notes, emphasizing that the Federal Reserve's cautious approach is warranted. With the economy generating approximately 230,000 jobs per month and the S&P 500 up 12.1% year-to-date, the Fed's strategy appears to be one of measured patience. "If we get one or two cuts this year, that will end up being quite good," he adds, suggesting that the market's initial expectations of more aggressive rate cuts were overly optimistic. ‘A sell-off across financial markets’ One of the most closely watched elements of the upcoming meeting will be the summary of economic projections (SEP) and the dot plot, which outlines the Federal Reserve's interest rate forecasts. Brusuelas anticipates that the Fed will likely reduce its forecast from three rate cuts to two. "If it turns out the dot plot is implying only one rate cut, you will see a sell-off across financial markets," he warns. This sentiment highlights the delicate balance the Fed must maintain to avoid unsettling investors. The dot plot's implications extend beyond immediate market reactions. A lower expectation for rate cuts signals the Fed's confidence in the economy's resilience. "A strong economy is good for equities," Brusuelas asserts, though he acknowledges the concentration of value in technology stocks, which are particularly sensitive to interest rate changes. Implications for Borrowers and Investors For those looking to borrow money or refinance existing debt, the Fed's cautious stance means that financing costs will remain elevated for the foreseeable future. "Financing costs are gonna remain elevated, and they're literally just going to have to bide their time until those rates come down," Brusuelas explains. This environment poses challenges for the real estate market and business owners needing to refinance debt initially secured at lower interest rates. Despite these challenges, Brusuelas remains optimistic about the Fed's long-term strategy. "The federal funds rate is restrictive relative to the long-run growth rate of the economy, which is still at 1.8%," he notes, suggesting that rate cuts will eventually come, albeit at a slower pace. The Broader Economic Context The upcoming Consumer Price Index (CPI) report, expected to show a modest 0.1% growth due to falling gasoline prices, could influence rate cut probabilities ahead of the Fed's meeting, according to Brusuelas. However, he cautions against overreacting to short-term data. "Too many people are fighting the last war," he says, referring to outdated comparisons to inflation battles of previous decades. He argues that the current economic environment is fundamentally different, shaped by post-pandemic structural changes and evolving global supply chains. Brusuelas also touches on the potential for the Fed to reconsider its 2% inflation target, a topic that has garnered increasing attention. "They need to be careful around this," he advises, suggesting that any official change should only come after inflation has stabilized at the current target. Looking Ahead As the Fed navigates this complex economic landscape, its primary focus remains on achieving a "glide path of inflation back to 2% without causing a recession," a task Brusuelas describes as "not an easy feat." With the next significant Fed event being the Jackson Hole Symposium in August, where discussions will likely center on the monetary transmission mechanism, the financial community will be closely watching for any signals of future policy shifts. As Brusuelas aptly puts it, "We have a very strong economy right now... This is the kind of economy you want, and the Fed is going to respond appropriately by not cutting rates and being patient." This approach aims to balance the need for economic stability with the goal of returning to a 2% inflation target, all while avoiding the pitfalls of past monetary policy missteps. Street Views David Mericle, Goldman Sachs economist (Cautiously Optimistic): “We think the Fed leadership would prefer…to show two cuts in 2024 to retain flexibility. But the key risk is that the median could instead show just one cut in 2024, especially if the May core CPI print comes in well above forecasts.” Esther George, former Kansas City Fed president (Neutral): “My expectation is the dots will show and confirm what I think the market has picked up, and that is fewer rate cuts with the inflation forecast holding.” Luke Tilley, chief economist for Wilmington Trust (Bullish): “By the time July 31st comes around, they'll have three more months of inflation data. I think they'll be back on the front of their feet and off their heels and ready to cut. But it really comes down to how that data comes out.” Nathan Sheets, global chief economist at Citi (Bearish): “The Fed’s narrative is going to be very similar to what we’ve been hearing: ‘We’ve made progress bringing down inflation; we’re not in a hurry to cut rates.’” |
