The Fed expects Goldilocks– we beg to differ

The Fed expects Goldilocks– we beg to differ

hamilton-derek

Derek Hamilton

  • Managing Director, Economist – Ivy Equity Boutique
  • Read bio

Four times each year, the US Federal Reserve issues forecasts from its members. This release, called the Summary of Economic Projections (SEP), gives investors a peek into what the Fed is thinking about gross domestic product (GDP) growth, inflation, unemployment, and interest rates. The most recent forecasts point to a gradual decline in interest rates over the next few years. Is this plausible?

We studied the Fed’s previous rate cut cycles, looking specifically at the magnitude of rate cuts (defined in percentage points) as well as the duration (in months) of the rate cut cycle. As you can see from the chart below, larger rate cuts tended to be spread over longer time periods. This typically held true whether the result was a recession or a soft landing.

The blue box in the chart shows the median expectation from all the participants attending the September 2023 Fed meeting. This forecast is clearly an outlier. Underlying this forecast is the expectation that GDP growth will fall to its long-term potential and stay there, while inflation falls back to the Fed’s 2% inflation target. As we have pointed out in the past, this has never happened. Economic growth will typically slow to below long-term potential and then either continue to deteriorate into recession or reaccelerate.

We see the rate outlook one of two ways: 

  1. The economy enters recession (our base case), inflation continues to fall, unemployment rises, and the Fed is forced to reduce interest rates much more quickly than the median suggests.
  2. Or, the economy enters a soft landing for a time, and then reaccelerates. In this scenario, unemployment likely falls further, and inflation reaccelerates, forcing the Fed to not only abandon any significant rate cuts, but likely pushing them to raise interest rates higher.

Either way, the Goldilocks scenario portrayed by the Fed seems extremely unlikely, in our view.

US Federal Reserve rate cuts: Size and duration

12 rate cut cycles (green dots) between October 1957 and April 2020

Note: Dotted gray line represents the trend line.

Source: US Federal Reserve, Macrobond, Macquarie.


Inside the markets

Chart-powered guide with macroeconomic perspectives and insights on the markets

Access here

[3139477]

This market commentary has been prepared for general informational purposes by the author, who is part of Macquarie Asset Management (MAM), the asset management business of Macquarie Group (Macquarie), and is not a product of the Macquarie Research Department.

This market commentary reflects the views of the author and statements in it may differ from the views of others in MAM or of other Macquarie divisions or groups, including Macquarie Research. This market commentary has not been prepared to comply with requirements designed to promote the independence of investment research and is accordingly not subject to any prohibition on dealing ahead of the dissemination of investment research.

Nothing in this market commentary shall be construed as a solicitation to buy or sell any security or other product, or to engage in or refrain from engaging in any transaction. Macquarie conducts a global full-service, integrated investment banking, asset management, and brokerage business. Macquarie may do, and seek to do, business with any of the companies covered in this market commentary. Macquarie has investment banking and other business relationships with a significant number of companies, which may include companies that are discussed in this commentary, and may have positions in financial instruments or other financial interests in the subject matter of this market commentary. As a result, investors should be aware that Macquarie may have a conflict of interest that could affect the objectivity of this market commentary. In preparing this market commentary, we did not take into account the investment objectives, financial situation, or needs of any particular client. You should not make an investment decision on the basis of this market commentary. Before making an investment decision you need to consider, with or without the assistance of an adviser, whether the investment is appropriate in light of your particular investment needs, objectives, and financial circumstances.

Macquarie salespeople, traders and other professionals may provide oral or written market commentary, analysis, trading strategies or research products to Macquarie’s clients that reflect opinions which are different from or contrary to the opinions expressed in this market commentary. Macquarie’s asset management business (including MAM), principal trading desks and investing businesses may make investment decisions that are inconsistent with the views expressed in this commentary. There are risks involved in investing. The price of securities and other financial products can and does fluctuate, and an individual security or financial product may even become valueless. International investors are reminded of the additional risks inherent in international investments, such as currency fluctuations and international or local financial, market, economic, tax, or regulatory conditions, which may adversely affect the value of the investment. This market commentary is based on information obtained from sources believed to be reliable, but we do not make any representation or warranty that it is accurate, complete, or up to date. We accept no obligation to correct or update the information or opinions in this market commentary. Opinions, information, and data in this market commentary are as of the date indicated on the cover and subject to change without notice. No member of the Macquarie Group accepts any liability whatsoever for any direct, indirect, consequential, or other loss arising from any use of this market commentary and/or further communication in relation to this market commentary. Some of the data in this market commentary may be sourced from information and materials published by government or industry bodies or agencies, however this market commentary is neither endorsed or certified by any such bodies or agencies. This market commentary does not constitute legal, tax accounting, or investment advice. Recipients should independently evaluate any specific investment in consultation with their legal, tax, accounting, and investment advisors. Past performance is not indicative of future results.

This market commentary may include forward-looking statements, forecasts, estimates, projections, opinions, and investment theses, which may be identified by the use of terminology such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “can,” “plan,” “will,” “would,” “should,” “seek,” “project,” “continue,” “target,” and similar expressions. No representation is made or will be made that any forward-looking statements will be achieved or will prove to be correct or that any assumptions on which such statements may be based are reasonable. A number of factors could cause actual future results and operations to vary materially and adversely from the forward-looking statements. Qualitative statements regarding political, regulatory, market and economic environments and opportunities are based on the author’s opinion, belief, and judgment.

Investing involves risk including the possible loss of principal. The investment capabilities described herein involve risks due, among other things, to the nature of the underlying investments. All examples herein are for illustrative purposes only and there can be no assurance that any particular investment objective will be realized or any investment strategy seeking to achieve such objective will be successful.

Past performance is not a reliable indication of future performance.

Gross domestic product (GDP) is a measure of all goods and services produced by a nation in a year. It is a measure of economic activity.

All third-party marks cited are the property of their respective owners.