Economic Outlook and Federal Reserve's Rate Cuts

Investing.com — Recent economic data is shifting market expectations toward the Federal Reserve potentially pausing its rate cuts, but conditions for this remain strict, according to Deutsche Bank strategists.

Following a 50-basis-point reduction in September, there’s a notable change in sentiment, speculating on when the Fed might skip a meeting.

Deutsche Bank's policy rule analysis indicates that further reductions are still possible under current conditions, predicting a 25-basis-point cut in December while keeping rates at the upper end of policy prescriptions.

Conditions for Pausing Rate Cuts

Deutsche Bank outlines two primary conditions for the Fed to consider pausing:
1. Stickier Inflation: Core PCE inflation needs to be consistently around 0.3%, indicating persistent price pressures that could hinder further cuts.
2. Stable Labor Market: There should be diminishing downside risks, characterized by steady payroll growth, an unemployment rate of 4.1% or lower, and improvements in metrics like quits and hiring rates.

Strategists believe these conditions might be met by December, though upcoming hurricane-affected data and the November CPI report may complicate this outlook.

“Our baseline is that the Fed will deliver a 25bp reduction at that meeting given their comfort with rates below 4.5%,” they added.

Long-Term Prospects

As 2025 nears, Deutsche Bank suggests the rationale for a pause could strengthen, primarily due to seasonal inflation effects that may impact Fed officials’ caution on further cuts.

They note, “The Fed will be closer to neutral estimates, with possible seasonal inflation effects lifting figures early next year. The election outcome may also induce hawkish risks.”

The potential election outcomes range from hawkish impacts based on a red sweep without tariffs to unique pressures from a Trump presidency or a Harris administration with a Republican Senate, depending on inflation and economic strength.

Rate Trajectory Sensitivities

The Fed’s rate adjustments are sensitive to its views on the neutral rate, linked to the concept of “r-star.”

Deutsche Bank's analysis shows a nominal neutral rate estimate around 3.5%, but determining the precise rate is challenging. With the current policy rate only about 125 basis points above this estimate, the Fed faces limited room for further cuts before nearing the neutral zone.

In conclusion, while a December rate cut appears likely, “policy decisions beyond November will still depend on data,” with early 2025 possibly marking a pivot to a pause if inflation and labor metrics support it.