With the Fed cutting rates one might be wondering what is next for interest rates. We review here what might lie ahead using the Fed forecasts which were accompanying the Fed meeting (Fed Summary of Economic Projections).
For a broader view on what typically happens during a monetary easing cycle we encourage the reader to review our in depth analysis: A (Short) Macro Guide To The Federal Reserve Interest Rate Cut Cycles.
Fed Fund Rate Projections
Using Fed projections we can see that after cutting interest rate by 0.50% to 5% the Fed also expects to cut rates by another 0.5% before the end of the year to 4.50% and then further reduce rates next year by another 1% toward 3.5%. The Fed also expects the longer term Fed Fund rate to be right around 3%.
Macro Data Projections
Next to providing forecasts about interest rate the Fed also makes projections about the economy. Overall in terms of economic data the Fed expects real GDP growing at around 2%, unemployment not moving much higher at around 4.40% and inflation continuing to decelerate from 2.60% currently to 2% next year
Data: Fed projection with Treasure computation (in green)
Interestingly we can also combine the Fed projections together to get a sense of where the Fed Fund rate will be compared to inflation as well as nominal GDP.
-Real Fed Fund rate: If we subtract the inflation from the Fed Fund rate we get what is called the “real Fed Fund rate”. Prior to September, the real Fed Fund rate was sitting at 3.00% (ie 5.50% - 2.50%). Based on the Fed forecast we can compute its future implied real Fed Fund rate which is expected to decline toward 0.9%. As the picture below shows this is below the long term average at 1.6% but still above the negative level seen in the 2010s.
-Fed Fund rate and nominal GDP: If we add the Fed inflation measure (ie PCE inflation) to its real GDP forecast we can get the Fed's expectation about nominal GDP (ie real GDP + Inflation) which is projected to be relatively stable around 4.6% next year and 4% in 2026. Interestingly based on our previous work (What is The Current Fair Fed Fund Rate?) we know that the relationship between nominal GDP and Fed Fund rate is approximately: Fed Fund rate = 0.8*nominal GDP. This would imply based on the Fed nominal GDP forecast that the “fair” Fed Fund rate should decline toward 3% which is consistent with the Fed forecast in terms of the Fed fund rate.
Overall
The September Fed meeting was an important one in terms of monetary policy as it doesn’t happen often that the Fed starts a monetary easing cycle (it only happened 7 times over the last 40 years ago). Based on the Fed forecast we should expect the interest rate to decline toward 3.5% next year (which is consistent with their macroeconomic forecast). There are also clear implications from monetary loosening in terms of broader financial markets that we reviewed previously (A (Short) Macro Guide To The Federal Reserve Interest Rate Cut Cycles) and as we concluded there what matters now is how the economy (and most importantly the job market) will behave.
Disclosure:Investing involves risk, including loss of principal. The information provided is for informational purposes only and should not be construed as investment, financial, legal, or tax advice. This material should not be considered an offer or recommendation to buy or sell a security, or a recommendation of any specific investment or strategy. You should consult your own financial, legal, and tax advisors before engaging in any transaction. While information and sources are believed to be accurate, Treasure does not guarantee the accuracy or completeness of any information or source provided herein and is under no obligation to update this information. For more information about Treasure, please visit treasurefi.com.
