The Federal Reserve will likely cut interest rates in the second quarter of next year regardless of whether the US economy enters a recession, Goldman Sachs' economics team wrote in a new research note on Sunday.
"The cuts in our forecast are driven by this desire to normalize the funds rate from a restrictive level once inflation is closer to target, not by a recession," Goldman Sachs chief US economist David Mericle wrote.
After one of the most aggressive rate-hiking campaigns in history, the Fed's benchmark interest rate currently sits in the range of 5.25% to 5.5%, the highest level since 2001.
With economists across Wall Street seeing less likelihood of a recession, and Goldman Sachs' (GS) own team projecting "unspectacular growth" but not a growth scare, inflation is the most likely catalyst for rate cuts. And inflation appears to be headed in the right direction.
Last week data from the Bureau of Labor Statistics showed core the Consumer Price Index, which strips out the volatile food and energy categories, increased 0.2% in July, the same increase as June. That marked the first time since February 2021 that core CPI rose just 0.2% in consecutive months and has many economists betting the Fed will hold rates steady at its next meeting in September.
Read more: What the Fed rate hike means for bank accounts, CDs, loans, and credit cards
Another inflation measure tracked by the Fed, the Personal Consumer Expenditures (PCE), has also recently shown inflation declines.
"(By Q2 2024), we expect core PCE inflation to have fallen below 3% on a year-on-year basis and below 2.5% on a monthly annualized basis, and wage growth to have fallen below 4% year-on-year," Mericle wrote. "Those thresholds for cutting align roughly with the annual forecasts in the FOMC’s Summary of Economic Projections and the conditions at the outset of the last cutting cycle motivated by an intent to normalize from a restrictive policy stance as inflation came down in 1995."
Goldman isn't alone in having the second quarter of 2024 circled next year. Bank of America and Wells Fargo both see cuts in that time frame as well. Bank of America's team of economists, which recently pushed back their projection for another Fed rate hike to November, sees cuts coming in June.
"The breadth of disinflation has increased in recent months, with outright deflation in some core goods categories," BofA US economist Michael Gapen wrote. "For example, the share of expenditure categories with three-month annualized inflation at or above 5% now stands at 23.2%, its lowest reading since November 2020."
To this point, Federal Reserve Chair Jerome Powell has talked little about rate cuts during his press conferences as he's noted inflation is still "well above our longer-run goal of 2 percent."
But the Fed's most recently released Summary of Economic Projections, including its "dot plot," which maps out policymakers' expectations for where interest rates could be headed in the future, shows rate cuts coming in 2024.
"When, people are writing down rate cuts next year, it just is a sense that inflation is coming down, and we’re comfortable that it’s coming down, and it’s time to start cutting rates," Powell said when asked about rate cuts during a July 26 press conference. "But I mean, there’s a lot of uncertainty between what happens in the next meeting cycle, let alone the next year, let alone the year after that."
Josh Schafer is a reporter for Yahoo Finance.
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