MNI INTERVIEW: Higher Trend Growth Means More Fed Cuts - S&P
MNI (WASHINGTON) - The Federal Reserve can continue to loosen monetary policy further despite signs of continued robust growth because the trend growth rate has likely increased and the neutral rate of interest is still a ways away, Global Chief Economist at S&P Global Ratings Paul Gruenwald told MNI.
"The new sustainable growth rate for the U.S. is 2.25%, whereas when we came into Covid it was actually less than 2%," he said. "Maybe the speed limit is even a little bit higher for the U.S. economy, but that means the interest rate structure can be a little bit higher as well."
A Fed interest rate cut next week is likely, he said, followed by three cuts in 2025 to end the year in a range of 3.5% to 3.75%. Gruenwald expects the Fed to reduce the federal funds rate more gradually than thought a few months ago, but more than markets currently expect, to reach a neutral rate of 3.1% by the end of 2026, a year later than previously envisioned.
The Fed next year at some point is "definitely going to stop cutting earlier than previously thought, maybe 3.5%," he said. (See: MNI INTERVIEW: Three Fed Cuts Before Mid-2025 Pause - Giannoni)
TREND GROWTH
The November payrolls report surprised slightly to the upside last week, unemployment is low at 4.2%, and the Atlanta Fed's GDPNow is above 3% for the fourth quarter, he said. "Looking at the way the economy is behaving, it doesn't look like we're that tight" on monetary policy, he said.
"The Fed's restrictive but I wouldn't characterize the Fed as super restrictive right now. They're probably closer to neutral than they think."
Various Fed officials in past weeks have said growth does not need to come down much in order for inflation to ease downward to the central bank's 2% inflation target.
"Specifically, robust growth in both the labor force and in productivity has meant that the economy can expand at a higher pace than we saw before the pandemic, without creating inflationary pressures," New York Fed President John Williams said last week.
The most recent estimates of trend growth from the New York Fed's Holston-Laubach-Williams models have risen to 2.5% from under 2% in the years before Covid.
INFLATION RISKS
"The U.S. is a USD30 trillion economy and taking the sustainable growth rate up a half a point is a big deal. That's a really nice hand to be dealt if you're a new administration," said Gruenwald. He expects growth to come in at 2.3% in 2024 and 1.9% in 2025, down from 3.2% in the fourth quarter of 2023.
Still, President-elect Donald Trump's proposed policies would risk growth in the medium- and longer-term and potentially reignite inflationary pressures, he said. "If you take the big three, which are tariffs, taxes, and immigration policy, all three of those look inflationary." (See: MNI INTERVIEW: Ex-Fed's Blinder Sees Stagflation Shock Ahead)
"The risks now are this new set of policy measures, which seems designed to stimulate the economy. The economy doesn't need any extra juice right now and it doesn't need any extra inflation pressure right now," Gruenwald said.