The Fed now sees just one cut

The Federal Open Market Committee left its benchmark rate at 5.25–5.50 per cent in June and cut its own forecast for easing this year. The updated dot plot now shows a single quarter-point cut in 2024, down from three. A mild May consumer price index reading did nothing to soften the committee.

Eight for one, four for none

The individual projections show how firm the mood is. Eight of the nineteen officials pencilled in just one cut, and four expected no easing at all this year. The Fed does not want to repeat its premature talk of cuts in late 2023. With the economy looking sturdy on the surface and financial conditions loose, the committee wants several months of good data before it moves.

The timing made the shift more striking. The May inflation figures landed on the morning of the decision and were the softest in months, with headline prices flat on the month and core prices up about 0.2 per cent. Officials were allowed to update their projections after seeing the release, and most evidently chose not to. The message is that one good month does not undo three bad ones at the start of the year, and the committee intends to see a run of them before acting.

Higher for longer, in writing

The projections went beyond this year. The median estimate of the long-run neutral rate, the level that neither stimulates nor restrains the economy, edged up to 2.8 per cent. That small change carries a large implication: if neutral is higher than officials thought, current policy is less restrictive than it appears, and the eventual easing cycle will stop at a higher level than markets assumed during the long era of near-zero rates. The projections for inflation this year were also nudged up, while those for unemployment were little changed.

The rate has now been at this level since July 2023, almost eleven months. The committee has tried to separate two questions, how high rates need to be and how long they must stay there, and it is now answering the second one with the word "longer". That is a form of tightening by patience, since real rates rise automatically as inflation drifts down while the nominal rate stays fixed.

There is a precedent for a long plateau. In June 2006 the Fed stopped raising rates at 5.25 per cent and then held them there for more than a year, cutting only in September 2007 once the damage from the housing market had reached the banks. That hold looked prudent while it lasted and too long in hindsight. The current committee knows the history, and its insistence on waiting for data rather than forecasts is a bet that this economy has fewer hidden fractures than that one did.

Through the pipes

The practical effect runs through the Treasury market. The two-year yield, which tracks expectations for the policy rate over the next couple of years, is the most sensitive to changes in the dots and sits close to the fed funds rate itself. Mortgage rates key off the ten-year yield, and both have stayed near 7 per cent for the thirty-year fixed loan. Banks set the prime rate off the policy rate, so credit card and home-equity borrowers see no relief until the committee acts.

The pressure falls unevenly. Large companies with investment-grade ratings locked in long-term funding at low rates during the pandemic and have barely felt the cycle. Smaller firms that rely on bank lines and leveraged loans pay floating rates and feel every month of delay. Households split the same way: owners with fixed-rate mortgages are insulated, renters and would-be buyers are not, and savers in money market funds continue to earn more than 5 per cent.

Abroad, the Fed now stands apart. The Bank of Canada cut its policy rate on 5 June and the European Central Bank followed the next day, both citing progress on inflation that America has yet to match. A Fed that holds while its peers ease keeps the dollar firm, which tightens conditions for emerging-market borrowers with dollar debts and makes American exports a little harder to sell.

The case that the Fed is too cautious

The dovish reading deserves a fair hearing. Inflation has come down a long way from its peak of more than 9 per cent in June 2022, and the labour market is cooling at the edges, with job openings down and unemployment edging up to 4 per cent. Policy works with long and variable lags, and a committee that waits for inflation to reach target before easing risks holding too tight for too long and causing the recession it hoped to avoid. Markets, which still priced close to two cuts after the meeting, lean towards this view.

The committee's counter is about asymmetric risk. Cutting too early and being forced to reverse would damage its credibility more than cutting a few months late, and the economy has so far absorbed high rates without a sharp rise in joblessness. The painful lesson of 2021, when it waited too long to tighten, has made it reluctant to act on forecasts rather than evidence. Until inflation readings confirm the trend, the burden of proof sits with the doves.

Readings that decide September

Four meetings remain this year: late July, mid-September, early November and mid-December. Market pricing puts the first cut in September or November. The inputs that matter most are the monthly core readings for both the consumer price index and the personal consumption expenditures index, and the payroll reports. Two or three more core prints near 0.2 per cent would probably bring a September cut into play; a return to 0.3 or 0.4 per cent would push easing to December or beyond.

The Fed has left itself almost no room for another bad inflation reading. If prices run hot again this summer, the one remaining cut will probably slip into next year, and the committee will accept that to protect its credibility. Borrowers should read the dots as a floor on how long relief takes: the first cut is unlikely before September, and a single quarter-point move by December would leave the prime rate and credit card rates almost exactly where they are today.