Landing the Beast

The Federal Reserve Open Market Committee (FOMC) reduced its target for interest rates by 0.50% to a range of 4.75 – 5.00%, kicking off the hiking cycle with a bang. Thus marks the third stage of the process begun two months ago: foam the runway (July FOMC), check the foam (August Jackson Hole Conference), and land the beast (Sept FOMC). Today’s 0.50% cut means Federal Reserve (Fed) officials are trying to bring it down aggressively, the tactical rationale being that a firm touchdown is the safest course of action when economic crosswinds are particularly blustery. When policy rates are far away from neutral, an aggressive approach is, in Fed thinking, safer. Moreover, the skew of future Fed outcomes beyond today’s cuts looks surprisingly dovish.

Data since the FOMC met in July has pointed towards strong output, slowing job growth, and easing inflation. Core GDP growth for 2Q measured +2.9%, a very healthy pace, and most estimates for 3Q have growth trending similarly. At this point, it is almost arithmetically impossible to have a contraction until early 2025, and that is very much a “maybe.” Job growth has meanwhile been decelerating, with the three-month average of payroll gains falling to 116K as of August, the lowest reading since the pandemic. Since labor markets are the source of consumer income, slower job growth clearly poses a risk, but it is not in and of itself significant enough to herald a recession. Inflation, meanwhile, continues to slow and, just as importantly, become less volatile. Through August, it looks like the 3-month annualized rate of core PCE inflation will measure 1.9 – 2.0%, which is the third such month of a similar run rate. In our view, there is a greater chance core inflation will fall below the Fed’s 2.0% target than going above 2.5% next year.

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