MNI INTERVIEW: Fed Could Cut When Core PCE Reaches About 2.8%

The Federal Reserve could begin lowering its policy interest rate once trailing 12-month core inflation falls to about 2.8%, which could come around the middle of next year, a former senior Fed Board researcher told MNI.

John Roberts, a former deputy associate director at the Fed Board in Washington who oversaw its domestic economic modeling efforts, said that with the Fed’s September outlook showing rate cuts by the end of 2024 with core inflation for the year of 2.6%, the Fed could well cut when 12-month core PCE is around 2.7%-2.8%.

"Presumably, 12-month core PCE would need to be somewhere below 3%," he said. As of October, the core PCE price index increased 3.5% from one year ago. "With the recent good news on inflation, that threshold will be reached somewhat sooner, now perhaps around mid-year 2024." (See: MNI POLICY: Fed Likely Done, Focused On Length Of Hold)

“In their revised output, they’re probably still going to want to have a real side outlook where growth is slowing below its longer run pace and the unemployment rate ticks up," said Roberts, who served at the Fed Board for more than 35 years. "However, they’ll likely let some of the good news on inflation and the supply side carry over into 2024, with inflation down a tenth or two in 2024 and 2025" compared to September SEP forecasts.

With the Fed unlikely to deliver the 25bp hike that a majority of the FOMC penciled into their 2023 projections in September, rate projections for future years will drop, reflecting the lower starting point, Roberts said.

"What does that imply for the funds rate? With the lower starting point along with the lower inflation outlook, the funds rate will likely be 25 basis points lower and it could even be 50 basis points lower for the end of 2024." That means the Fed's SEP could show a median year-end 2024 rate of 4.9% or 4.6%.

HARD LANDING SCENARIO

"Inflation will be the main thing they're going to be focused on but not only the headline number but also the details over different time horizons and they'll want similar stories from other measures such as the Dallas Fed's trimmed mean," said Roberts, now a senior adviser at Evercore ISI.

"Before they start cutting they'll also want wage growth to be coming down to something that's consistent with inflation being in the 2.5% range and with the anticipation that it will eventually get lower still."

Asked about the potential for cuts in a scenario with quicker disinflation to 2.3% next year, Roberts pointed to the Fed's September SEP that showed 150 basis points of cuts through 2025. While it is not the baseline scenario, Roberts also suggested above average risk of a hard landing could bring about inflation closer to 2% and 150 basis points of cuts. The market is pricing in 108 basis points of cuts in 2024 as of Monday morning in Washington.

Fed Chair Jay Powell at this week's press conference is going to be in a tough situation because the central bank's inflation and funds rate forecasts are going to be coming down for the end of next year, he said.

“They will probably still want to see further loosening in the labor market and therefore some weaker growth next year," said Roberts, a former special adviser to then-Fed Governor Lael Brainard from 2017 to 2019. "There's a bit of tension there and Powell will be trying to tamp down enthusiasm in financial markets."