The latest ‘dot plot’ of the level of US policy rates that each member of the central bank’s Federal Open Market Committee (FOMC) deems ‘appropriate’ at the end of 2024, 2025 and 2026 at first reading appears more hawkish than in March.
Indeed, the median point for the benchmark federal funds rate at the end of this year is now 5.125%. That corresponds to just one 25bp rate cut by the Fed in 2024 (the median point in the current 5.25-5.50% range is 5.375%). That is much less than the three cuts totalling 75bp that had been considered appropriate in December 2023 and March 2024.
The details of the individual projections show that four FOMC members are now contemplating a status quo until the end of the year, seven favour one cut and eight two cuts.
One week after the latest FOMC meeting, market-based expectations (OIS rates in the graph) are pointing to around 4.80% for the overnight rate at the end of the year – that implies two policy rate cuts. The futures market reflects 100bp in cuts in 2025.
As for the ‘appropriate’ longer-term federal funds rate (aka the equilibrium rate, the neutral rate, or r*), the level has changed from March’s 2.562% to 2.75% in June. Within the FOMC, four members think it could between 3.50% and 3.75%; five see it at or slightly above 3.0% and for 11 members, it stands at around 2.5%.
Before the pandemic, a large consensus was for a neutral rate at 2.5% for the US economy. Economists are debating whether r* has risen or not since then. If it is the case, it means that the economy could operate at its potential (a form of equilibrium) with higher policy rates than before.
As at end March, Loretta Mester, president of the Cleveland Federal Reserve and a voting member of the FOMC this year, said in a speech that she had raised her estimate of the longer-run federal funds rate from 2.5% to 3%.
We may eventually see a gradual rise in the longer-term appropriate funds rate as central bankers revise their estimates.
