MNI INTERVIEW-Fed Could Cut Fewer Than 3 Times In '24-Friedman

Federal Reserve policymakers will stay cautious about cutting interest rates this year given strong growth and volatile inflation, and there's a rising chance they will deliver even fewer than the three cuts embedded in official projections, former New York Fed economist Steven Friedman told MNI.

“Three rate cuts as a base case this year still looks reasonable, but the risks are now increasingly skewed to fewer than that and a later start,” he said in an interview. “This is going to be a very cautious cutting cycle.”

This view contrasts starkly with market pricing of just a few weeks ago for as many as six rate cuts. Fed officials have since pushed back against such a prospect, and seemed to have raised the bar further with speeches highlighting that the central bank has not in the past cut rates while economic growth is robust.

“It does feel like there has been a little bit of a shift to this view that while the economy's going strong, we can be even more patient and cutting we can really just focus on the inflation side,” said Friedman, who spent 15 years at the New York Fed including as director of market analysis, and is now a senior macroeconomist at MacKay Shields. “That’s probably because the economy has actually outperformed their expectations.” (See MNI: Fed Messaging Swings Boost Policy Volatility-Ex-Officials)

Friedman said he expects the economy to grow around 2-2.5% this year, citing factors keeping activity buoyant despite what he sees as a “somewhat restrictive” monetary policy stance – including low locked-in interest rates by households and firms as well as ongoing support from fiscal policy.

BUMPY DISINFLATION

Recent disappointingly strong readings on inflation have made it more difficult for Fed officials to embrace rate cuts, Friedman said.

“I'm not sure if we can count on the sort of goods deflation that we've seen continuing month after month, especially seeing that real wage growth has picked up and that can power consumer spending," he said.

The stronger inflation print for January, even if it’s an anomaly, puts the Fed further away from achieving its forecast for year-end inflation, he said.

“You would need to have core PCE annualized 2.2% over the rest of the year to still hit their 2.4% core target, which really opens the door to those three rate cuts. Just one or two more firm core prints, and by firm, I mean, something like 30 basis points for core PCE, that really increases the chances that easing gets pushed off into the latter half of the year,” he said. (See MNI INTERVIEW: Fed To Stay Patient Given Bumpy Inflation-Groen)

Looking further ahead, Friedman says it’s likely the economy has entered a higher inflation regime post pandemic.

“The real dividends from globalization are probably behind us. The investment that's occurring for the energy transition but also the costs associated with climate change – those to me suggest a higher structural inflation environment,” said Friedman.

HIGHER INFLATION VOLATILITY

Even if the disinflation trend holds over the medium term, inflation patterns have become more volatile on a month-to-month basis than they had been in the two decades preceding the Covid pandemic. That is likely to make this rate cutting cycle less predictable than markets are currently prepared for, said Friedman.

“I do think we're in this period of higher inflation volatility, which means that even if the committee's projections for rate cuts are reasonable, we shouldn't necessarily assume that we're going to see three cuts evenly spaced out this year and four cuts evenly spaced out next year,”

Instead, he said, the Fed could opt for cutting rates then holding for some time, taking “more of a stop-go approach to an easing cycle than markets are expecting,” akin to what Alan Greenspan did in the mid-1990s.