Why We Think 5 Interest-Rate Cuts Are Coming in 2024

Ivanna Hampton: The Federal Reserve is holding off cutting interest rates for now, like expected. Sticky inflation is raising questions about whether the road to the Fed’s 2% target will be a bumpy one. So, what should investors expect? Senior US economist for Morningstar Research Services Preston Caldwell is here to provide his insights. Thanks for joining me, Preston.

Preston Caldwell: Hey, Ivanna. Thanks for having me.

Will Interest Rates Drop in 2024?

Hampton: The Federal Reserve kept their forecast for three rate cuts this year. What do you think the Fed needs to see to feel confident about lowering its benchmark rate?

Caldwell: It was kind of an uneventful meeting. So, markets had known with high confidence for the last couple of months that the Fed was not going to cut in this meeting. Just given that Powell had kind of thrown cold water on the notion of rate cuts in its last meeting, and also we had an uptick in inflation in January and February’s data. So, the results of the meeting were set in stone. Investors, if anything, were just cluing in on whether the Fed’s projections would change, and they really haven’t changed much. Despite the uptick in inflation, that did cause the Fed’s fourth-quarter 2024 inflation forecast to tick up slightly to 2.6% year over year from 2.4% previously.

Nonetheless, we, as you mentioned, didn’t have any change in the Fed’s rate-cut forecast for 2024. Still expecting three rate cuts, even though I think a few voters may have changed their views, but the median expectation is still three rate cuts. And I think that’s just because the Fed is still pretty even-keel in its assessment of inflation. It’s not drifting as much as the market is in either a pessimistic or optimistic direction just based on the latest data. It’s more looking at the very long-run trend, which is to say that inflation is coming down. It’s been a bumpy road, as Powell noted, but it is making progress to 2%. As that happens, it will eventually be appropriate to cut rates this year.

When Will the Fed First Cut Interest Rates?

Hampton: And you forecast six cuts in 2024. What’s your thinking now? And when do you predict the first interest-rate cut?

Caldwell: About a month ago, I had changed my forecast actually. I had originally thought there would be a cut in March, and six rate cuts altogether in 2024. But a little over a month ago, I changed that forecast to five rate cuts just based off the inflation data coming in higher in January and February. With that said, I’m still expecting five rate cuts this year with the first one coming in either the May or most likely the June meeting. Because I do think despite the uptick we’ve seen in the last two months, overall inflation continues to trend down. It was in the second half of 2023 at just 1.9% in terms of core inflation. Now on a year-over-year basis, that core inflation rate remained at 2.8% as of February. So, we’re not quite down to 2.0% yet, but we’re drifting in that direction. And I think not only will we continue to see relief in terms of goods prices coming down, which has helped to drive inflation down greatly over the last year, but we’ll also start to see progress on housing inflation coming down, which the leading-edge data still indicates quite strongly that will happen. And so ultimately, I think that will add up to the Fed cutting five times this year and also cutting more in 2025 than the Fed currently expects. So, altogether by year-end 2025, I think the federal-funds rate will come down to 2.25%, which is actually 150 basis points below what the Fed is currently projecting. And that’s based off of our greater optimism on inflation coming down.

Federal Reserve’s Longer-Term Outlook

Hampton: Now interest rates set near zero before the pandemic. What has the Federal Reserve signaled about their longer-term outlook for rates?

Caldwell: For quite a while, they’ve been at 2.5% as their long-run expectation for the federal-funds rate. And then I think in this last meeting, it ticked up to 2.6%. So, I wouldn’t read much into that minor adjustment, just a few people revising their long-term forecasts. But we should watch it and see if it becomes a trend. It would be interesting to see if the Fed does start to bake in a higher-expected long-term interest rate. Before the pandemic in the post-global-financial-crisis environment, we had interest rates much lower than historical levels. But actually, it’s really been a four-decade-long trend to lower interest rates driven by factors like demographics and lower productivity growth. So, all that suggests that the environment of low interest rates that was prevailing prior to the pandemic is not a cyclical or temporary development but is a long-term development. And so, it would require shifting those long-run trends if we were going to see a new higher for longer, a new normal of higher interest rates. So, our view is that really interest rates eventually settle back down about to where they were before the pandemic. And that’s still basically what the Fed is baking in as well.

Hampton: Well, Preston, thank you for your insights and your time today.

Caldwell: Thanks, Ivanna.

Watch Fed Unlikely to Cut Interest Rates in March, but What About May? for more from Preston Caldwell.