MNI INTERVIEW: Fed To Cut Twice In '24, Start Sept - Sheets

The Federal Reserve will need at least two more months of good inflation data to feel confident about the trend of underlying inflation, making September the earliest the central bank can begin lowering interest rates, former Fed board economist Nathan Sheets told MNI.

"There will be enough improvement in the inflation process that the Fed's going to have scope to to start its cutting cycle in September," Sheets said, adding he expects two quarter-point cuts this year. "What you're waiting for is evidence that the terrible months are the outlier and the signal is in a trend of good inflation data."

A trifecta of inflation readings for May – CPI, PPI, and import prices – surprised to the downside last week, and many of the underlying details in the reports were encouraging and indicate disinflation is likely back on track, he said. Core PCE inflation should come in at 2.6% over the year through May, but the Fed will need to see a string of similar reports.

"It seems to me they are going to be following the three-month rule. They had three really bad months and they'll want three months of good data. They can't get there by July. You would need a downward economic shock to put it on the table." (See: MNI INTERVIEW: FOMC Won’t Agree On Cuts Until December-Pingle)

The Fed also has breathing room on its labor mandate due to increased supply, he added. "They don't really have much of a trade off in their dual mandate goals" at the moment, he said.

HIGHER NEUTRAL

Sheets said whether the Fed begins to lower rates in September or December will have little impact on the economy and real activity. "The macroeconomic difference between a 2.3% real rate and 2.05% real rate is inconsequential and not really perceptible to the naked eye."

The Fed will need to move in small steps and assess their moves when the cutting cycle begins, Sheets said, but after a few interest rate cuts the brunt of the impact will be on interest-rate sensitive sectors.

"Once you put together several rate cuts and if you have a percentage point, then that is going to start to influence behavior and one concrete application is the mortgage rate and housing."

Fed Chair Jerome Powell last week said the FOMC is "coming to the view that rates are less likely to go down to their pre-pandemic levels" and noted officials marked up their view of the longer-run neutral rate to 2.75%, the highest since early 2019.

The Fed will likely continue to move up their estimates of neutral to about 3% over time and interest rates will come down to a level slightly above that in an every-other-meeting pace, said Sheets, now Citi global chief economist after an 18-year career at the Fed board.

"In this environment where you're expecting a soft landing and gradual disinflation, to be able to gradually take some of the heat off the economy in quarterly cuts to preserve the solid performance makes a lot of sense," he said. "Of course, if you're in a place where activity is unexpectedly softer, you could get faster cuts."