From the Field

After the Fed pivot, what’s next?
Tim Murray, CFA, Capital Markets Strategist Multi-Asset Division

The Federal Open Market Committee delivered a surprisingly dovish signal at its December meeting. Chairman Powell had spent most of 2023 telling us that the Fed would prioritize fighting inflation over supporting the economy for the foreseeable future. But in December they changed their tune. The new message was: Cuts are coming.  

In the Fed’s Summary of Economic Projections, they projected three 25-basis-point cuts in 2024. But the fed funds futures market took a more aggressive stance, pricing in seven cuts in 2024. The market also raised the probability of a cut at the March FOMC meeting to above 80% as of the end of December.

However, in January some of the optimism about cuts has been walked back, leaving investors debating what exactly is next from the Fed. The big questions are:

  1. When will they start cutting?
  2. How many cuts should we expect in 2024?

Let’s take a look at each one of these questions.

Question #1: When will they start cutting?

One way to make an educated guess is to use history as a guide. During the six Fed hiking cycles since 1980, the average amount of time between the final hike and the first cut is 6.7 months. And with the Fed having already been on pause for six months, a cut in March would be nine months after the last hike. In fact, there is only one cycle where the pause lasted longer: June 2004, which lasted 15 months.

We can also use market projections as a guide. As of January 23, the fed funds futures market wasn’t pricing in a full cut until the May 1 FOMC meeting.

Question #2: How many cuts will there be in 2024?

Again, we can use history as a guide. If we review the seven Fed cutting cycles since 1980 and assume the first cut is at least three months away, we determine how much the Fed Funds Effective Rate fell during the first nine months of each cutting cycle. The average reduction was 2.5%, which is equivalent to 10 cuts. However, the range of outcomes is very large, including a reduction of only 75 basis points and a reduction of 800 basis points.

But the flaw in this analysis is that it assumes that all historical cutting cycles were the same. They were not. During five of the seven cutting cycles, the U.S. economy went into recession. Meanwhile, the remaining two cycles—the ones beginning in September 1984 and June 1995—were examples of “soft landings.” Given that it is now consensus opinion that the U.S. will not have a recession, perhaps these two cycles are a better gauge of the current environment.

During those two cycles, the Fed stopped cutting within eight months of the beginning of cuts. In 1984 to 1985, the Fed lowered the rate from 11.75% to 7.75% over eight months—a 34% reduction. In 1995 to 1996, the Fed lowered the rate from 6% to 5.25% over seven months—a 13% reduction. 

So the average reduction during the two soft-landing cycles was 23.5% of the peak rate, which would be equivalent to the Fed lowering the current 5.5% rate to 4.2%, for a total of 5.2 cuts.

Again, we can also use market projections as a guide. As of January 23, the fed funds futures market was pricing in 5.47 cuts—a similar outcome to the historical soft-landing average.

So what should we expect from the Fed in 2024? History says that if we avoid recession, the reduction in the fed funds rate will be somewhat modest, and the market more or less agrees.

But the key determinants will likely be inflation and the labor market. If inflation stays on its current disinflationary track, the Fed will feel comfortable cutting rates at a measured pace—similar to the one currently priced into the market. However, if inflation heats up again, the Fed will be forced to slow down the pace of cuts considerably—perhaps even pausing after only one or two cuts. And lastly, if the labor market begins to show signs of extreme distress, we may see the Fed speed up its cutting cycle considerably, in hopes of avoiding recession.

Key Insights
  • Reduced expectations that the Federal Reserve will begin cutting interest rates in March have left investors wondering when—and how far—U.S. rates will fall in 2024.
  • Based on past Fed hiking and cutting cycles, we expect modest rate cuts, although the Fed’s actions will be influenced by inflation and labor market conditions.

Following the Fed’s unexpected pivot away from monetary tightening in December 2023, futures markets aggressively began to price in seven rate cuts in 2024, far exceeding the three cuts of 25 basis points (bps)1 each projected in the Fed’s Summary of Economic Projections. Since then, however, market optimism has cooled, reviving questions about when and how far rates will fall this year.

In the past six Fed hiking cycles since 1980, the first rate cut occurred 6.7 months, on average, after the final rate hike (Figure 1). At the end of 2023, futures markets were pricing in a more than 80% chance of a March rate cut. By January 23, 2024, futures markets were projecting a full cut in May. Since the Fed has been on pause since July 2023, a rate cut in March would be nine months after the last hike. Only during the hiking cycle that began in June 2004 was there a longer pause, one which lasted 15 months.

When will the Fed start cutting rates?

(Fig. 1) Fed hiking cycles

A line chart showing the trajectory of the last six Fed rate hiking cycles since 1980 relative to the current hiking cycle that began in March 2022.

1980 to January 23, 2024.
Past results are not a reliable indicator of future results. Actual outcomes may differ materially from forward estimates.
Source: Bloomberg Finance L.P.

How many Fed cuts in 2024?

(Fig. 2) Cumulative number of rate cuts priced in by Fed funds futures market

A bar chart showing how many rate cuts have been priced in by the Fed fund futures market as of January 23, 2024.

As of January 23, 2024.
Actual outcomes may differ materially from forward estimates.
Source: Bloomberg Finance L.P.
A basis point is 1/100th of one percentage point.

A review of the past seven Fed cutting cycles since 1980 shows that the average rate reduction in the first nine months of each cutting cycle was 2.5%, an equivalent of 10 25-bp cuts. However, these reductions varied widely—from 75 bps to 800 bps—reflecting the varying economic environments.

During five of the past seven cutting cycles, the U.S. economy went into recession. The remaining two cycles—those starting in September 1984 and June 1995—were “soft landings,” which provide a better guide in the current economic environment, in our view. In the two soft-landing cycles, rates declined by an average of 23.5% from the peak level. Applied now, the same percentage reduction would lower the federal funds rate target from 5.5% to 4.2%—equaling 5.2 cuts of 25 bps each. Notably, as of January 23, the funds futures market was pricing in a similar outcome, 5.47 cuts in 2024 (Figure 2).

If the U.S. economy remains on track for a soft landing, we expect modest rate cuts in 2024. However, the Fed’s actions will depend heavily on inflation and labor market conditions. If inflation heats up, the pace of rate cuts is likely to slow considerably. But if the labor market shows signs of extreme distress, the Fed could speed up cuts to try to avoid a recession.

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1 A basis point equals 1/100th of a percentage point.

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