All Aboard the Express Train to Neutral

Key takeaways:

• StoneX’s Kathryn Rooney Vera predicts a half percentage point rate cut now, while the Fed’s policy rate is farthest from neutral
• The move is aimed at giving the U.S. economy the best chance of a soft landing
• The Fed is on course to get the funds rate down to around 4.375% by December

StoneX Chief Market Strategist Kathryn Rooney Vera gave her insights into whether the Federal Reserve will cut its benchmark short-term interest rate by a quarter percentage point or half percentage point at its policy meeting on September 18.

While news reports indicated that it’s a tight race between the rates, Rooney Vera said, “With all of the data in hand we suspect the Fed will move by a half percentage point, but we don’t rule out the possibility of it making a more modest quarter-point move with language that assures more cuts are coming soon.” No matter the cut, Rooney Vera expects the move to be accompanied by communication of the Fed’s intention to make continued rate cuts “as it sees new data.”

Rooney Vera now believes that getting the federal funds rate to a more neutral level of nearly 3%, which the central bank predicted in June as a two-year task, can be achieved in only one year. “Fed Chairman Jerome Powell is about to call ‘All Aboard’ on his express train to neutral.”

With inflation down sufficiently, Powell and other Fed officials seem convinced that economic conditions no longer warrant an interest rate more than two percentage points above neutral. The Fed’s estimate of neutral is a little under 3%.

Rooney Vera writes, “We suspect the neutral rate is above 3% and we wouldn’t be surprised to see some small upward adjustments to those estimates by the central bank.”

As to the future, Kathryn expects residual disagreement among officials about where rates will end the year. “As always,” she said, “it depends on the data. For 2025, we estimate officials will write down another percentage point of interest rate cuts, perhaps 1.25 percentage points, depending on how they finish 2024. That will bring rates down by roughly two percentage points by the end of next year, with some modest downward adjustments thereafter.”

That would chart a course to a fed funds rate of about 4.375% by December.

“With further reductions in the first half of 2025 it would get the rate to just above 3% by mid-year next year,” Rooney Vera stated. “Then later in 2025, the central bank’s debate would turn toward slowing the pace of cuts.” She thinks the Fed will stop making cuts before the rates get below 3% while remaining reluctant to declare a neutral rate above 3%.

As to the coming rate cut, Rooney Vera said, “Our call for a half percentage point rate cut rests on the argument that the best time for a bigger move is now when the Fed’s policy rate is farthest from neutral.”

Powell and other officials have always made decisions based on their judgment of what’s best for the economy; getting to a neutral rate is now the mission.

The safer path would be a quarter-point cut with a strong signal that further rate cuts are ahead, but with word that the debate continues among officials, expectations have shifted. Failing to deliver on a half-point now might be considered risky.

Rooney Vera summarized, “We think after a rigorous internal debate Powell will take the bigger swing at the rate and then set out at his press conference to assure the public that the move is aimed at giving the U.S. economy the best chance of a soft landing that the Fed can deliver.”

Dive Deeper: Access Kathryn Rooney Vera’s Analysis

For more in-depth analysis on global market trends and investment strategies, subscribe to "Macro Strategy by Kathryn Rooney Vera.” This comprehensive suite of reports offers expert insights on socio-economic and political trends influencing global markets, authored by StoneX's Chief Market Strategist.

Read the original article here: LINK