If Harris wins, the Federal Reserve may quickly cut interest rates next year

The team at the Financial Times in the UK recently updated their forecast for the future of the Federal Reserve interest rates. The following is the full text.

Following a 50 basis point rate cut in September, we still believe that the Federal Reserve will cut rates twice more by 25 basis points each in 2024.

Since our recent forecast, the September employment report and inflation data have been significantly stronger than expected. Additionally, data that had shown weak job growth in the past few months has been revised significantly upwards, indicating that previous concerns about the labor market slipping into a recession were unfounded. Recent rapidly changing retail sales data also indicate that American consumers still have resilience, suggesting that consumer spending may continue to rise in the third quarter.

These new pieces of information have led some market participants to worry about the possibility of a "no landing" scenario in the US economy, where the Federal Reserve fails to bring inflation down to target levels under the current policy setting and is eventually forced to raise rates again. The market currently expects less than 2 remaining rate cuts in 2024, down from over 4 just a month ago.

We continue to expect two more rate cuts from the Federal Reserve this year. The September employment data continued the volatility in this series of data, and it is more likely that it was just a strong month in the broader trend of gradual labor market easing. We are also pleased to see that housing inflation, a major structural reason for overall strong inflation growth, decreased in September.

Nevertheless, we believe that interest rate risks are skewed to the upside. In addition to neutral rates being higher than the Federal Reserve's expectations, meaning that the current policy setting may be looser than rate setters believe, our long-term assessment of the Federal Reserve's rate path is also based on fiscal conditions similar to the present. However, with the increasing possibility of a Republican landslide victory in the November elections, the risk of the Federal Reserve tightening policy in response to unrestrained fiscal expansion next year is also higher.

Below is our expectation for the future rate cut path of the Federal Reserve.

November this year

We expect the Federal Reserve to cut rates by 25 basis points in November, bringing the benchmark rate to 4.5-4.75%.

Although the September employment and inflation data suggest a smaller likelihood of a larger rate cut, the "no landing" scenario is not our base forecast.

Current data still broadly align with the Federal Reserve's basic expectations - a gradual anti-inflation trend, which will provide a basis for further rate cuts. Since the release of inflation data, several hawkish policymakers have publicly stated that loose policy should continue, but at a gradual pace.

Overall, we still believe that the Federal Reserve will cut rates again at this meeting. However, if the October employment report is once again very strong, the Federal Reserve may choose to hold steady.

By the end of this year

We believe that the Federal Reserve will cut interest rates by a total of 100 basis points by the end of this year, bringing the federal funds rate down to 4.25-4.5%. This is in line with the economic forecast summary from the Federal Reserve in September. However, this forecast is based on a fiscal outlook similar to today's.

If inflation accelerates again in the coming months, or if the labor market maintains the strong momentum seen in September's data, the Federal Reserve may pause rate cuts, or only cut rates by 25 basis points by the end of the year. This is the main risk in our forecast.

If the labor market weakens rapidly in the fall, economic activity slows down, and the risk of an economic recession increases, the Federal Reserve will significantly ease its policy. However, given the strong performance of the data in September, we believe that the Federal Reserve will not be willing to make another significant rate cut by the end of the year.

First Half of 2025

We believe that if Harris wins the U.S. presidential election, the Federal Reserve will cut rates three more times in the first half of 2025, each time by 25 basis points, bringing the policy rate down to 3.5-3.75%.

The core belief of the Federal Reserve is that the economy is heading towards gradually rising inflation and a gradual slowdown in the labor market, so it no longer needs a restrictive monetary policy.

Due to the significant gap between the current policy setting and policymakers' assessment of the neutral rate, we believe the Federal Reserve will front-load rate cuts in the first half of 2025. If it cuts rates three times in the first half of 2025, it will be just one cut away from a reasonable assessment of the neutral rate.

However, we see two main risks, both pointing towards a slower pace of easing.

First, the Republican Party wins big in the upcoming elections, enabling the party to push for comprehensive fiscal expansion matching the tariffs. These policy decisions will lead to inflation and may prompt the Federal Reserve to cut rates at a slower pace.

The second risk is the "no landing" scenario becoming a reality, as monetary policy is not as tight as the Federal Reserve currently estimates. If inflation does not further decrease, and the labor market remains strong, the Federal Reserve's actions will be slower than our current expectations.

The Federal Reserve may also cut rates at each meeting in the first half of 2025, keeping the benchmark rate at 3.25-3.5% by the end of June. This scenario would occur if the labor market sharply weakens at a faster pace. However, current data does not indicate this possibility.

2025

We believe that the Federal Reserve will cut rates a total of four times in 2025, by 25 basis points each time, bringing the policy rate to 3.25-3.5%. This is consistent with the latest assessment by policymakers in the September dot plot This pace of interest rate cuts is consistent with gradual policy normalization, aiming for inflation to trend towards the 2% target, economic activity to slow down, and wage growth to slow down as unemployment rises.

At the same time, this situation also depends on whether fiscal policy continues on a path similar to today, with the Democratic Party controlling the White House and the Republican Party controlling Congress, limiting the Democratic Party's ability to fully implement its fiscal agenda.

As for the scenario leading up to June 2025, as mentioned earlier, a major risk we see is the Republican Party winning big or the U.S. economy not "landing". Both scenarios would result in benchmark interest rates by the end of 2025 being higher than expected.

If the labor market significantly slows down later in 2024 or early 2025, the Fed's rate cuts may also exceed our current expectations.

Long-Term Neutral Interest Rate

Our long-term interest rate forecast remains unchanged, with the neutral interest rate expected to be around 3.25%.