Cutting for the first time is always the most difficult

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In recent discussions, the focus has shifted from speculating on the severity of the US recession and whether it has already begun, to considering the possibility of a “no landing” scenario where employment and spending remain strong. However, some experts believe that with inflation easing, the Federal Reserve may still need to lower interest rates in order to avoid being overly restrictive, regardless of whether a recession occurs. Goldman Sachs, known for its bullish perspective, has projected the first rate cut by the Fed to take place in the second quarter of 2024.

Goldman Sachs’ economics team predicts that the core personal consumption expenditures inflation rate, which is the Fed’s preferred measure, will drop below 3% on a year-on-year basis and under 2.5% on a monthly annualized basis by that time. This would provide sufficient justification for the Fed to implement the rate cut, citing the need to normalize the funds rate from a restrictive level once inflation is closer to the target.

However, the report also indicates that Goldman Sachs’ confidence in this projection is relatively modest. They highlight several key points, emphasizing that normalizing interest rates is not an urgent motivation for cutting, and therefore there is a significant risk that the Federal Open Market Committee (FOMC) will choose to keep rates steady. Furthermore, they disagree with the notion that falling inflation requires rate cuts to prevent real interest rates from rising and negatively impacting the economy. Their uncertainty about the pace of rate cuts leads them to cautiously estimate a reduction of 25 basis points per quarter, depending on the FOMC’s desire for normalization and their evaluation of the inflation situation.

Goldman Sachs expects the funds rate to eventually stabilize between 3-3.25%, above the FOMC’s median longer-run projection of 2.5%. They have been more hawkish in their views compared to market pricing this year, anticipating a lower probability of recession and having a higher threshold for rate cuts. However, as concerns about recessions have diminished, the gap between their views and market expectations has narrowed.

Considering the current trajectory of inflation, a wait-and-see approach followed by gradual interest rate cuts seems reasonable. However, it’s important to note that trajectories can change, and unforeseen events may occur in the world before 2024. Moreover, the Fed’s concerns about its credibility and the potential fallout from previous messaging mishaps suggest that unless there is a major economic downturn, they will likely wait to see inflation closer to or below 2% before implementing rate cuts.