Fed minutes indicate that 50 bps rate cut was a tough call

10 Oct 2024 , 10:49 AM

OPPOSITION, NEUTRALITY, AND AMBIVALENCE

When the Fed presented its monetary policy statement on September 18, 2024; it almost appeared like the decision to cut rates by 50 bps was the general view. However, while that may have been the median view, it was far from being the general view. As the minutes of the September FOMC meeting, published on October 09, 2024 indicate, Michelle Bowman may have just the more visible opponent of a 50 bps rate cut; other members were sceptical too. In fact, the minutes do indicate that only a handful of FOMC members looked totally convinced about a 50 bps rate cut in September 2023. The others were broadly divided into 3 groups; viz, opposition, neutrality and ambivalence.

In terms of opposition to the 50 bps rate cut, only governor Michelle Bowman was firmly opposed to the decision to cut rates by 50 bps. Bowman was not opposed to the rate cut; she just felt that 25 bps would have been sufficient. Michelle Bowman also stated explicitly that a 50 bps rate cut ran two risks. The first risk was that the markets could interpret the move as an announcement by the Fed as its formal victory over inflation. That was not the real story. Also, Bowman felt that the 50 bps rate cut may appear like the US growth story is in dire straits and it needs a monetary boost from the Fed. That was, once again, not the correct picture. According to Bowman, a 25 bps rate would have signalled a change of course, and would have also avoided giving the wrong signals to the market.

However, Bowman may have just been the most visible face of opposition to the 50 bps rate cut; but there were other sceptics too. For instance, some of the members of the FOMC fell into the Neutral group. These members eventually voted in favour of the 50 bps rate cut, but would have been equally comfortable with a 25 bps rate cut. In fact, they would have been more comfortable with a 25 bps rate cut, which would have looked more calibrated. The third and final category was the ambivalent group, who were not to sure about whether 50 bps rate cut was the right decision. However, they were also not sure if ambivalence could be a cogent reason for a dissent vote. If you add up the dissent vote of Bowman; to the votes of neutrality and ambivalence, the road to 50 bps rate cut may not have been all that simple. At least, that is what the FOMC minutes appear to indicate.

CIRCA FED MINUTES (OCTOBER 2024) – SIX KEY READINGS

The minutes of the September 18, 2024 Fed meeting were published by the FOMC late on October 09, 2024. Unlike the RBI, which publishes the minutes after 14 days, the Fed publishes the minutes after 21 days. Here are our 6 key readings from the FOMC minutes and its implications for the future trajectory of interest rates.

• The broad message from the minutes was that while the Federal Reserve officials during the September 18, 2024 meeting, concurred on the need to cut rates, they were unsure of the quantum of rate cuts. While most members favoured 50 bps rate cut, a small number of members did express misgivings saying that 50 bps may be too large to start.
• In retrospect, the sceptics were fairly close to the truth. If you look at the data flows since the last meeting, the growth concerns are really looking less than serious. For instance, in the last 2 months, the unemployment has come down from 4.3% to 4.1%. Also, payroll additions in September at 254K was much higher than the average. Also, the GDP growth for Q2-2024 was at 3.0%; with Q3-2024 GDP expected at 3.2% as per the inputs coming from the Atlanta Fed GDP estimates.
• While the consensus was for a 50 bps rate cut in September, the decision was fairly hard fought due to the presence of several sceptics in the FOMC. The FOMC was not too sure of how aggressive the rate cuts should be, considering it was the first such rate action in 4 years. On the other hand, the Fed is already accused of falling behind the curve on rate hikes in 2021; and does not want to invite similar criticism in cutting rates.
• Some of the FOMC members sitting on the fence, wanted assurance that inflation was moving sustainably lower and were less worried about the jobs picture. Ultimately, only Michelle Bowman was vocal enough to offer a dissenting vote. Bowman observed that she would have preferred a 25 basis point reduction of the target range at this meeting, and a few others indicated that they could have supported such a decision. They admitted that a 25 bps cut would have been in sync with calibrated predictability.
• What the minutes of the FOMC also indicate is that these are just early days of an easing cycle. However, the minutes also suggest that future cuts may not be as aggressive as the September move. That means; 50 bps more in 2024 and another 100 bps in 2025 may actually be on the higher side. An interesting takeaway was that members also wanted a clear communication that recalibration of policy stance should not be seen as evidence of a less favourable economic outlook or a signal of rapid dovishness.
• The debate in the FOMC also saw members pointing out that, in the past, a 50 bps rate cut had only been undertaken in times of an economic crisis; as exemplified by the global financial crisis (GFC) of 2008 or the pandemic of 2020. The rate cut of 50 bps in September 2024 had happened despite being in the midst of relatively normal macro-economic conditions.

The gist of the relatively tentative minutes was visible in the bond markets with the bond yields actually inching above the 4% mark. Most likely, the dovishness of the Fed is likely to be calibrated, going ahead.

FED OCTOBER MINUTES AND IMPACT ON CME FEDWATCH

The table below captures the rate cut probabilities over the next 10 Fed meetings, based on the implied probabilities in the Fed futures trading; post the Fed minutes publication.

Fed Meet	225-250	250-275	275-300	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500
Nov-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	84.8%	15.2%
Dec-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	1.6%	83.4%	14.9%	Nil
Jan-25	Nil	Nil	Nil	Nil	Nil	Nil	1.2%	62.8%	32.2%	3.8%	Nil
Mar-25	Nil	Nil	Nil	Nil	Nil	1.0%	50.5%	38.3%	9.4%	0.8%	Nil
May-25	Nil	Nil	Nil	Nil	0.5%	28.1%	43.8%	22.5%	4.7%	0.3%	Nil
Jun-25	Nil	Nil	Nil	0.3%	16.6%	37.3%	31.4%	12.1%	2.2%	0.1%	Nil
Jul-25	Nil	Nil	0.1%	5.7%	23.4%	35.3%	25.1%	8.8%	1.5%	0.1%	Nil
Sep-25	Nil	Nil	2.1%	12.0%	27.6%	31.7%	19.3%	6.2%	1.0%	0.1%	Nil
Oct-25	Nil	0.5%	4.3%	15.5%	28.6%	28.9%	16.4%	5.1%	0.8%	Nil	Nil
Dec-25	0.1%	1.3%	6.8%	18.4%	28.6%	26.1%	13.9%	4.1%	0.6%	Nil	Nil

Data source: CME Fedwatch (# – lower probabilities consolidated)

Here is a quick look at how the rate cut probabilities panned out after the Fed minutes of the September 18, 2024 FOMC meeting were published on October 09, 2024. In the last one week, the undertone of the CME Fedwatch appears to have shifted to being more cautious about future rate hikes. In fact, even the CME Fedwatch is reconciling to the fact that the rate cut story may not be so aggressively dovish, after all. Here is a quick summary.

• With the September rate cut of 50 bps done for now, the focus shifts to November and December FOMC meets. The CME Fedwatch gives a probability of 84.8% to 25 bps rate cut in November 2024; with anything beyond that not on the radar.
• What about the first milestone of December 2024? By then, there is 85.0% probability of total 50 bps rate cut (100 bps in all). However, now there is a 15 bps probability that the Fed may not cross 3 rate cuts in 2024; which means just one more rate cut between November and December due to the robust growth data.
• Let us turn to June 2025 milestone. The CME Fedwatch is assigning 85.6% probability for overall 150 bps rate cuts from the peak and 56.2% chance for 175 bps rate cut from the starting point of the cycle.
• Let us come to the final milestone of December 2025. At this point, the CME Fedwatch is estimating 81.4% probability for 175 bps of rate cuts from the peak and a probability of 55.3% for 200 bps of rate cuts by December 2025. So, it looks very likely that the US Fed rate could settle 175 bps to 200 bps lower by the end of December 2025.

What is the immediate reading of the drift of the CME Fedwatch post the minutes? One message is that the CME Fedwatch is now getting less dovish that its own previous expectations as the data on growth and jobs appear to be much stronger than originally feared. The CME Fedwatch is still pencilling 75 bps to 100 bps overall rate cut by end of 2024 and 175 bps to 200 bps overall rate cuts by end of 2025.

READING BETWEEN THE LINES OF OCTOBER 2024 FED MINUTES

The FOMC minutes of the September 18, 2024 FOMC meeting, published on October 09, 2024, shows that the fight for a 50 bps rate cut was a lot more intense than it appeared. Here is what we could read between the lines of the FOMC minutes.

• Clearly, the decision for a 50 bps rate cut was far from simple. The support came only partially from the believers in dovishness. The balance support also came from the sceptics and those who would have preferred to sit on the fence. That is the context in which the Fed statement must be seen. It may look like an aggressive kick-off, but many of the members would have, probably, been emphatic in their support for 25 bps rate cut too.
• The concern for many members were sitting on the fence was of predictability, especially considering that the Fed is also seen upon as the manager of inflation expectations. Even some of those who voted for a 50 bps rate cut actually believed that a small rate cut would have given a more predictable picture of policy normalization.
• One of the arguments put forth by the 50 bps rate cut club was that once the slowdown became apparent, other macroeconomic spillover effects would get triggered and addressing them becomes tougher. Hence, it was a conscious choice to be a little aggressive and even a little proactive in addressing any possible growth concerns. The Fed, obviously, does not want the face the criticism of being late on rate cuts, the way it has been pulled up for being late on rate hikes. Most experts believe that rate cuts should have started in late 2021, rather than in March 2022.
• The minutes also noted that the growth indicators had turned rapidly positive in the last 3 months since the street was first shocked by the 4.3% unemployment in July and the 1.4% GDP growth in Q1. Since then, unemployment is down to 4.1% and GDP growth is up above 3%. That is the context for why bond yield sent above 4% post the minutes. It is less about doubts on the Fed’s ability to rein in inflation and more about a thumbs up for the strength of the US economy.
• In a recent speech at the ECB in Germany, governor Adriana Kugler had pointed out that economic revival in the US was also on account of rapid cross-skilling, lateral shifting of jobs and a substantial improvement in labour productivity. These are important points the Fed must keep in mind in their rate trajectory calculations.

With the Fed statement and the minutes done for now, the focus shifts to the other macro data points. More than the consumer inflation and the PCE inflation, the markets would be focused on the core inflation, which seems to be the real issue. Of course, a lot would also depend on how the GDP numbers and the unemployment data pan out, going ahead.

4 QUESTIONS FOR THE RBI AFTER THE FED MINUTES

What does the RBI do going ahead, especially in the light of the Fed minutes. Remember, the RBI monetary policy was just announced on October 09, 2024 and the RBI had again maintained status quo on rates. How the RBI reacts to the Fed minutes would depend on its answers to these four questions.

• Does it seem logical that the RBI cuts rates at a time when the GDP growth is expected to be 7.2% in FY25 and had touched 8.2% in the previous year FY24? Remember, never in the past has the RBI cut rates at a time when the growth was so robust.
• Secondly, is the RBI fully in control of inflation. While food inflation may benefit from a bumper Kharif output this year, the risk of a spike in fuel inflation is still quite strong in the midst of the crisis in West Asia. Also, with the supply chains normalized, the core inflation is trying to find a higher equilibrium.
• Unlike the post-pandemic scenario; the global central banks are less in sync on the monetary policy approach to revive their economies. That means; the RBI runs limited risks of monetary divergence, as there are monetary believers on the hawkish side and the dovish side of the debate.
• Lastly, the one call that the RBI needs to take is on the cost of funds and the impact on corporate solvency and on capital formation. After all, the rates are 135 bps above the pre-COVID levels and real rates of interest are now above 2%.

With controlled inflation and robust growth, the RBI is no hurry to act. However, it would have to crystallize its thinking so it can take the final interest rate call by the December 2024 or the February 2025 RBI MPC meetings.