Federal Reserve Begins To Talk Interest Rate Cuts As Inflation Cools

(KNSI) – A local economist says the Federal Reserve pleasantly surprised the market last week when it signaled three interest rate cuts were expected by the end of 2024.

The estimate appeared when the Federal Reserve Open Market Committee projections were released, which come out only four times per year. St. Cloud State University’s King Banaian leans towards private sector experts who are saying there could be even more than that.

“So, if you think by the end of ’24 that the inflation rate’s going to be 2.5%, private forecasters reading that inflation forecast are saying, ‘Well, you’re not going to stop with just three rate cuts. If you actually hit that target, you’re probably going to cut a lot more.'”

The real interest rate is calculated by subtracting the inflation rate from the federal funds rate. Economists have differing views on what the real figure should be set at, but Banaian says around 1% sounds about right. If inflation is down to 2.5%, the federal funds rate would have to drop to near 3.5%. Right now, it is at 5.5%, a full two percent higher.

There are some things complicating a change in policy. Banaian says it’s an open question if consumers will feel as excited. It comes down to whether people are focused more on the rate of change in prices or the overall levels themselves.

“Suppose you used to pay $4 for a dozen eggs, and now you pay $6. So, your inflation rate was 50%. Over the next six months, the price stays at $6. Someone might say, ‘Well, the inflation rate’s now at zero,’ but maybe the consumer is looking at it saying, ‘But remember when it was four, and now it’s six, so it’s still bad.'”

Banaian says deflation can cause incredible stress on the banking system. Officials will not leave interest rates alone if inflation continues to fall, but a consumer revolt against easing could slow the pace of future rate cuts. He also notes that the Fed has traditionally avoided aggressive rate cuts during an election season.

Another factor to consider is the concept of a soft landing. The Fed has yet to commit to the idea that it could rein in inflation without harming the economy, but it is coming around to the notion. The median forecast for unemployment is only 4.1% for 2024, which is low enough that many would second guess rapid rate cuts. There is no rush to ease monetary policy if you are near full employment.

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