When will the Fed cut interest rates?

Economist on the central bank's thinking

When will the Fed cut interest rates?

With market observers anxiously keeping an eye out for smoke signals on interest rate cuts from the Federal Reserve, central bank chair Jerome Powell gave his strongest indication yet last weekend that lower rates are coming – but not imminent.

Speaking in a Sunday interview on CBS’ 60 Minutes, Powell all but confirmed rate cuts were on the way at some point in 2024, although he poured cold water on the prospect of a dramatic move to lower the Fed’s funds rate in March.

The Fed needs to see firmer evidence that inflation is heading decisively in the direction of its 2% target, Powell said, before moving ahead with rate cuts. “I think it’s not likely that this committee will reach that level of confidence in time for the March meeting, which is in seven weeks,” he noted.

While the Fed’s funds rate doesn’t directly move US mortgage rates in either direction, it’s one of the factors weighed by mortgage lenders in setting their own rates – and the onset of rate cuts would mark a clear signal that the central bank’s efforts to cool the economy have reached an end.

Expectations of a March rate cut had swelled prior to last week but plunged when Powell pushed back against the idea following the Fed’s opening rate decision of the year, which saw the funds rate remain unchanged.

Stunning news from the labor market on Friday also appeared to obliterate any chance of the Fed lowering its rate in the coming weeks, with the US economy adding a spectacular 353,000 jobs in a blockbuster report that shattered analyst estimates.

Was the market too optimistic about chances of a March cut?

Robert Dietz (pictured top), chief economist of the National Association of Home Builders (NAHB), told Mortgage Professional America that with inflation unlikely to return to the Fed’s target range in the coming months, a rate cut in early 2024 was always a fanciful prospect.

“I’ve sort of taken the view that the bond market was being too optimistic in terms of when the Fed would begin to reduce rates,” he said. “The internals of our macro forecasts suggest the inflation variable the Fed targets, the core PCE [personal consumption expenditures] rate of inflation, doesn’t reach the 2% target on a sustained basis until 2025.

“So this is a process. I think the bond market maybe got out ahead of itself a little bit in terms of thinking how quickly the Fed was going to cut rates.”

That was in large part because few had predicted the US economy to show such resilience in the opening months of this year, Dietz added, with January jobs figures coming in roughly twice as high as most analysts had expected.

Why wage growth could be a boost – and a pitfall – for the economy

A solid and growing labor market is positive for housing demand, helping generate household formations and allowing younger Americans to move out and rent or buy – but wage growth in the latest jobs report could be a cause for concern for the Fed, according to Dietz.

Wages increased by 4.5% on a year-over-year basis in January, a quicker pace than in December, in a development that could potentially prove a double-edged sword.

“That’s one of those things that could be good news and could be bad news,” Dietz said. “If wage growth is supported by productivity growth, then that kind of wage growth is great – that’s about as close to a free lunch as you can get in terms of economics.

“If productivity growth is stagnant or even declining – we’ve had some recent periods of productivity decline – then that kind of wage growth is an inflationary signal and would suggest that the Fed is not going to be in any hurry to ease monetary policy conditions.”

The likely end result of the Fed’s current deliberations, according to the economist, is two or three rate cuts this year – supported not by the emergence of a recession, as once widely expected, but rather by the central bank maintaining a constant restrictive policy to help tick inflation back towards 2%.

“As inflation itself comes down, the Fed can ease nominal rates to maintain constant inflation-adjusted restrictive rates,” Dietz said. “That easing is part of the drawdown in inflation itself, and I think that’s the path we’re on.

“If you ignore the first two quarters of 2022 where we had GDP declines, and you kind of put to the side that the housing market definitely went into a recession during 2022 and 2023, looking forward it looks pretty close to the soft landing. And that’s good news for housing demand.”

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