Be patient.

2024.9.21:

The Fed kicked off the big rate cut cycle with a 50 basis point rate cut and acknowledged that we have to get closer to its neutral rate of around 3%. The balance of risk has already begun to tilt towards the deteriorating labor market. So the Fed wants to start this process and start it with a bang.

What the Fed is sending: The Fed is normalizing policy and basically admitting that inflation has come a long way. They believe that inflation will get closer and closer to 2%. The Fed has a dual mandate, it has to worry about the labor market, and we have seen the deterioration of the labor market. In the latest "Summary of Economic Projections" released, the unemployment rate is about 4.4%, and it will remain at the same level by next year. So the Fed acknowledges that the labor market has cooled, but does not want the labor market to deteriorate.

Outlook for the US economy: The Fed has done a lot of work to deal with inflation shocks and their reversals. The Fed wants a soft landing of the economy while the economy continues to grow. The current GDPNow model of the Atlanta Fed is about 3%, slightly above potential growth. The Fed wants the labor market to continue to grow, not to get weaker. So this is very good news. As I said, the Fed acknowledges that its long-term interest rate is close to 3%. And 5.5% is too tight for an economy that is close to potential in terms of employment, inflation, and growth.

Keep data dependence intact: The Fed remains in data dependence mode. The market's bias is stronger, with the target of another 50 basis point rate cut this year already set in the Summary of Economic Projections. We have to consider each meeting and the data collected. If we see further deterioration in the labor market, we may see the Fed cut interest rates directly by 50 basis points at one meeting. But if you think about it, what the Fed is going to do over the next year or so is to get interest rates closer to 3%, the neutral rate. The journey from 5.5% to 3% is about 10 cuts of 25 basis points each time. It will readjust at each meeting based on the full data received.

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