MacKay Shields LLC reposted this
Following the soft June core CPI reading, markets are discounting about 150 basis points of policy easing over the next twelve months, as reflected in forward overnight index swap rates (chart below). In contrast, at the June meeting the median FOMC participant projected 125 basis points of easing by the end of 2025. While more aggressive than the Fed’s June projections, market pricing strikes me as reasonable. As I wrote last week (and as Powell said during his Congressional testimony a few days ago), the labor market is unlikely to be a source of inflationary pressure going forward. More importantly, as inflation continues to cool, the FOMC will increasingly focus on preventing too-rapid a slowdown in aggregate demand and hiring. This will require getting the policy rate down closer to a more neutral setting sooner rather than later. Lower inflation, even if still moderately above two percent, will afford them this flexibility. Policy adjustments will increasingly resemble Greenspan’s strategy of “opportunistic disinflation,” where going the last mile on returning inflation exactly to target loses its allure if it would come at the cost of too-sharp a slowdown in the economy. Also, we should keep in mind that the “lock-in” effect in the mortgage market is a double-edged sword. Once the Fed turns to easing, the fact that such a modest proportion of households have mortgage rates above 5 percent means that a handful of interest rate cuts will not prompt a refinancing wave, which in prior easing cycles has allowed households to reliquefy balance sheets, supporting consumption.
