The Fed expects Goldilocks– we beg to differ

The Fed expects Goldilocks– we beg to differ


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.

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