In this note, we use our models to simulate what the Fed staff and the FOMC could see in September, that is the output of our models putting Q3 in-sample under reasonable assumptions. The models show pi* at 2.5% and gently trending lower. FRB-US shows around 30bps of cumulative cuts in 2024. In summary: a cut in September is not the baseline, not even assuming a slowdown in core prices in the next few months. Therefore, we think that the Fed can cut rates in September if either (i) there will be signs of serious weakness in the labor market, or (ii) implicitly accepting the risks of remaining a bit above target going forward.
Technical assumptions behind our exercise
We assume that real GDP will grow 2.4% (QoQ saar) in Q2, and let the model evolve endogenously going forward. We assume the unemployment rate at 3.9% in Q2, and let the model forecast its evolution endogenously. We assume that core PCE price inflation will be 2.8% (QoQ saar) in Q2 and 2.3% in Q3 (we currently expect the following MoM: 10bps in May, 20bps average in Jun-Jul-Aug, and 21bps in Sep). We assume that ECI wage growth will be 3.9% (QoQ saar) in both Q2 and Q3, and that labor productivity growth will average 2% in Q2 and Q3. Finally, we assume that inflation expectations will remain broadly stable going forward. (We reminder the reader that we run simulations on-demand. Therefore, if someone disagrees with our assumptions, we can re-run the models using her/his own forecasts for Q2 and Q3).
Results
The Figures below show the output of our models putting 2024:Q3 in-sample. In other words, the Figures show our current best guess of what the models output can look like at the time of the September FOMC. Here are the takeaways:
- The “main” model forecast (Figure 1) is likely to project core PCE price inflation at 2.8% in 2024 (Q4/Q4), 2.5% in 2025, and 2.5% in 2026. For comparison, at the time of the June 2024 FOMC meeting, the model was projecting core PCE at 3.2% in 2024, 2.8% in 2025, and 2.7% in 2026.
- Pi* is likely to be estimated at 2.5% or just below it in Q3 (Figure 2). Compared to recent FOMC rounds, pi* would remain very persistent, although marginally lower and gently disinflating (Figure 3). The estimate at 2.5% in Q3 comes from averaging:
- The trend models (Figure 4) are likely to signal that the persistent part of inflation will be around 2.5%. In Figure 4, the average of the models goes from 2.50% in Q2 to 2.48% in Q3.
- Because we are assuming that inflation expectations will remain broadly stable, the Fed CIE (Common Inflation Expectations) model –not shown in this note– is likely to remain at the current level, which is compatible with readings in core PCE space just above target (at 2.1%).
- The general equilibrium model “OUI” (Output, Unemployment, and Inflation – Figure 5), is likely to estimate pi* at 2.8%, roughly stable compared to the current run.
- As for the path of the FF rate, conditional on our assumptions, FRB-US shows around 30bps of cuts in 2024 with the FF rate finishing the year at 4.94% (Figure 6). Compared to the run at the time of the June 2024 FOMC meeting, the path of the FF rate is slightly more dovish but the model continues to project only one cut in 2024 (financial variables path available here). Finally, stochastic simulations (available here) around the baseline show a non-zero but still low probability of a cut in September (the second cut is barely within the 90% intervals).
Conclusion
There is nothing impossible in life. But the bar for a cut in September continues to be quite high, and possibly higher than most perceive at the moment. Ultimately, it seems that it requires either ultra-low readings of core PCE from now until September (and still, even in that case it might not be enough), or some signs of (serious) weakness in the labor market. Otherwise, the Fed would cut implicitly assuming a slightly higher target (pi*) going forward.
Figures
Figure 1. “Main” model forecast for core PCE price inflation – 2024:Q3 in-sample.
Figure 2. The estimate of pi* assuming to be in September 2024.
Figure 3. Evolution of pi* – 2024:Q3 in-sample.
Figure 4. Trend inflation models – 2024:Q3 in-sample.
Figure 5. “OUI” (Output, Unemployment, and Inflation) model – 2024:Q3 in-sample.
Figure 6. FRB-US model forecast (red line) and June SEP forecast (blue dots) – 2024:Q3 in-sample.
