The Fed’s "Mild" Easing Cycle: Fitch Predicts 250 Basis Points of Cuts Over 25 Months
The U.S. Federal Reserve’s upcoming easing cycle will be "mild" by historical standards when it starts cutting rates at its September policy meeting, according to ratings agency Fitch. While the Fed is expected to begin easing, the pace is likely to be gradual due to lingering inflation concerns.
Key Takeaways:
- Fitch forecasts 250 basis points of rate cuts over 25 months, with initial cuts of 25 basis points each in September and December followed by larger cuts in 2025 and 2026.
- The Fed’s easing cycle will be significantly slower and shorter than previous easing cycles, which saw a median cut of 470 basis points over 8 months.
- Persistent inflation is the main reason for the Fed’s cautious approach, as CPI inflation remains above its 2% target and core inflation has shown signs of stickiness.
- China is expected to continue cutting rates, with deflationary pressures becoming entrenched in the economy.
- Japan, on the other hand, will maintain a hawkish stance, driven by its belief that reflation is firmly entrenched, leading to a "virtuous wage-price cycle."
A Cautious Fed: Balancing Inflation and Growth
Fitch’s analysis highlights the delicate balance the Fed faces between battling inflation and supporting economic growth. While inflation has cooled somewhat, it remains stubbornly above target. The recent decline in core inflation, largely driven by falling automobile prices, may not be sustainable, causing the Fed to err on the side of caution.
"One reason we expect Fed easing to proceed at a relatively gentle pace is that there is still work to do on inflation," the report said.
The Fed’s approach reflects its recent struggles to tame inflation, which has persisted for longer than anticipated. This has highlighted gaps in the central bank’s understanding of inflation drivers, leading to a more conservative approach to easing.
"The inflation challenges faced by the Fed over the past three and a half years are also likely to engender caution among FOMC members. It took far longer than anticipated to tame inflation and gaps have been revealed in central banks’ understanding of what drives inflation," the report noted.
A Contrasting Asian Landscape: China Eases, Japan Tightens
While the U.S. navigates a cautious easing cycle, the Asian economic landscape paints a contrasting picture. China is expected to continue easing its monetary policy, driven by deflationary pressures and a weakening US dollar, which creates room for further rate cuts.
"Fed rate cuts and the recent weakening of the US dollar has opened up some room for the PBOC to cut rates further," the report stated.
The PBOC’s decision to cut the 1-year MLF rate in July came as a surprise to markets, indicating a growing concern over deflationary forces in the Chinese economy. Falling producer prices, export prices, and house prices, coupled with declining bond yields and core CPI inflation, necessitate further easing measures. Fitch has lowered its CPI forecasts for China, now expecting an inflation rate of 0.5% in 2024.
In contrast, Japan is expected to maintain a more hawkish stance, continuing to raise rates as it believes reflation is firmly established.
"The [Bank of Japan] is bucking the global trend of policy easing and hiked rates more aggressively than we had anticipated in July. This reflects its growing conviction that reflation is now firmly entrenched," Fitch explained.
With core inflation exceeding the BOJ’s target for 23 consecutive months, coupled with companies committing to "ongoing" and "sizable" wage increases, the Japanese economy is showing signs of a "virtuous wage-price cycle." This gives the BOJ confidence that it can raise rates towards neutral settings without causing significant economic harm.
Fitch expects the BOJ’s benchmark policy rate to reach 0.5% by the end of 2024, 0.75% in 2025, and eventually 1% by 2026. This hawkish stance, in contrast to the global trend of easing, could have global ramifications.
The Impact of Diverging Policies: A Global Puzzle
The contrasting monetary policy approaches of the U.S., China, and Japan present a complex global economic puzzle. The Fed’s cautious easing, coupled with China’s continued easing, could create a divergence in global growth trajectories. Conversely, Japan’s hawkish stance could impact currency markets and global interest rates, potentially affecting global financial markets.
In conclusion, Fitch’s analysis highlights a complex global economic environment where policy decisions are driven by unique domestic circumstances. While the U.S. navigates a cautiously easing path, China seeks to combat deflation, and Japan aims to solidify its reflationary environment. The impact of these divergent monetary policies on the global economic landscape remains to be seen.
