12/20/24: FOMC 2024 Update: Hawkish Rate Cut, Inflation Outlook

The Federal Open Market Committee (FOMC) concluded their final meeting of 2024 this week and effectively ‘marked to market’ their go forward forecasts via the quarterly update to the Federal Reserve’s Summary of Economic Projections (SEP). Although the FOMC met market expectations by reducing the Fed Funds rate by 25 basis points to a range of 4.25% to 4.50%, it was viewed as a ‘hawkish’ ease by market participants linked to the SEP. In the Chandler team’s view, the updated SEP reflects the continued resiliency of the US economy and the corresponding risk of inflation taking longer to reach the FOMC’s two percent objective in 2025. Despite the higher interest rate environment over the past year, financial conditions have been benign in 2024, with equity markets posting outsized year-to-date total returns and both investment grade and high yield bond spreads near year-to-date lows. Regarding the details in the quarter-over-quarter changes to the SEP forecast, notably the inflation outlook for 2025 deteriorated, with the central tendency on Core PCE inflation increasing to a range of 2.5% to 2.7% in December 2024 compared to the 2.1% to 2.3% forecast as of September 2024. Correlated to the inflation forecast change, the FOMC’s projected appropriate policy path also increased across all tenors, with the Long Run Fed Funds forecast inching higher to a current range of 2.8% to 3.6% compared to the prior 2.5% to 3.5%.

Although the FOMC meeting was the outsized catalyst for the move higher in Treasury yields over the course of the week, the economic calendar was also meaningful. Retail sales were marginally above expectations, at 0.7% compared to the 0.6% consensus forecast with small upward revisions to the prior months. The Retail Sales Control Group, which contributes more heavily to the GDP calculation, was also solid at 0.4% for the month. The current Atlanta Fed GDP Nowcast estimate for fourth quarter GDP is 3.1%, another data point exhibiting the resiliency of the US economy. The market also digested updates to the official third quarter GDP forecast, with the number increasing to 3.1% compared to the prior estimate of 2.8%. The markets did receive some positive news on the inflation outlook, as the headline and core Personal Consumption Expenditures (PCE) index came in a tenth below expectations on a month-over-month basis for both, at 0.1% on Friday morning, however the year-over-year numbers are still elevated 2.4% and 2.8%, respectively.

The Chandler team outlook for monetary policy in 2025 is unchanged, we continue to forecast the cadence of normalizing the Fed Funds rate will moderate with both the Federal Reserve and market participants probing where the nominal neutral interest rate lies. Based on current Fed Fund futures contracts, the market is pricing in a Fed Funds rate of just under 4% in the third quarter of 2025, a large adjustment compared to the just above 3% estimate as of September 30, 2024. Our core view also calls for continued Treasury curve normalization, and although the spread between two year and ten-year Treasury notes is now positive, given the domestic fiscal outlook we believe the spread should continue to have a widening bias. We anticipate yields in the front end of the yield curve will contract in 2025, as the market’s assessment of the current trajectory of monetary policy is too onerous in our view. Although inflation is still above the Federal Reserves target, and has been choppy of late, we still believe the trajectory will be lower in 2025, providing the Federal Reserve with the ability to continue to normalize the Fed Funds rate and promote their dual objective of full employment and stable prices.

Next week: Chicago Fed National Activity Index, Consumer Confidence, Durable Goods, New Home Sales, and Jobless Claims

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