Fed's Conservative Inflation Projections Could Mean Two Rate Cuts

U.S. monetary policymakers’ views on the appropriate path for the federal funds rate — summarized in the so-called dot plot — are always closely scrutinized by investors. The median policymaker now favors only one cut for this year, compared to three cuts in the previous dot plot. While some observers saw this as a sign that the FOMC has turned more hawkish, we have a different interpretation. Let’s take a closer look.

First, let’s do some simple math. Only four policymakers thought it would be appropriate to keep rates unchanged this year. Among the remaining 15, a small majority (eight) viewed two cuts as appropriate, while the remaining seven preferred just one. This led to the median view of one cut, reached by a slim margin. And, as if to emphasize this point, the Chair highlighted that he can’t really distinguish between these two outcomes, seeing both as plausible. We heard this as the Chair minimizing the significance of the median view.

Chair Powell described FOMC participants’ inflation projections as “fairly conservative,” which we understood as him downplaying the magnitude of the upward revisions to the projections for this year and next. In this context, conservative means that the forecasts were too high, suggesting that they are especially subject to downside risks. Given that the outlook for rates is closely tied to that for inflation, we believe the median dot for this year is also too high, suggesting that two rate cuts are more likely than one this year.

We also see a reasonable chance that some of the projections were already somewhat stale. The Chair volunteered that most policymakers don’t update their projections to reflect data released during FOMC meetings. The data in this case was the consumer price index (CPI), which he called “certainly a better inflation report than almost anybody expected.”

So, to us, inflation remains the key data to watch. While characterizing the latest CPI report as “building confidence,” the Chair noted that “we’ll need to see more good data to bolster our confidence that inflation is moving sustainably toward two percent.” He called attention to the upcoming month-over-month changes in consumer prices over the second half of this year, pointing out that the upcoming 12-month changes might be exaggerated by the low inflation readings in the second half of last year. We’ll be watching the month-over-month changes closely.