BofA predicts deeper Fed rate cuts despite hawkish tone - 75 bps in Q4 and 125 bps in 2025

In a recent analysis, Bank of America (BofA) highlighted the Federal Reserve's recent 50 basis points (bps) rate cut, which was presented as a "recalibration" of monetary policy rather than the onset of a more aggressive rate-cutting cycle. Despite the Fed's optimistic stance, BofA expressed skepticism that the central bank's efforts would suffice, forecasting deeper rate cuts in the near future. We think the Fed will get pushed into deeper cuts. It now expects another 75 bps of rate cuts in the fourth quarter (December quarter) and 125 bps in 2025.

Hawkish messaging 

BofA observed that the Fed's messaging, both in its dot plot and in comments made by Chair Jerome Powell, was surprisingly hawkish given the rate cut. Chair Powell emphasised that the cut was not a response to labour market concerns but part of an adjustment to bring rates closer to neutral. The Fed's Summary of Economic Projections (SEP) also painted a broadly optimistic picture, projecting stable growth and a faster decline in inflation.

However, markets did not fully align with the Fed's outlook. According to BofA, markets have priced in an additional 70 bps or more of cuts for the remainder of the year, creating a disconnect between the Fed’s messaging and market expectations. BofA predicted that the Fed would be pushed to implement another 75 bps of cuts in the fourth quarter and an additional 125 bps in 2025, ultimately bringing rates to a neutral level of 2.75-3%.

Fed Statement: A Mixed Message

The Federal Open Market Committee (FOMC) statement included notable changes, but they were not as dovish as the rate cut might have suggested. BofA highlighted that the statement reflected confidence in achieving inflation targets and noted that risks related to inflation and employment were "roughly in balance." A key addition was a reference to the Fed’s commitment to "maximum employment," an important shift in its communication.

Interestingly, Governor Michelle Bowman dissented from the decision, marking the first time a Fed governor had done so since 2005, indicating some internal disagreement over the policy move.

A Confident SEP, But Hawkish Dots

The SEP released alongside the rate decision was notably confident, projecting above-trend growth and a faster path toward lower inflation. While the Fed raised its unemployment forecast to 4.4%, this was seen as a reflection of current data rather than a significant shift in outlook.

However, the Fed’s dot plot raised eyebrows. It showed a median forecast of just 100 bps of cuts in 2024, with nearly half the committee predicting only a 25 bps cut later this year. BofA suggested that this hawkish projection created a credibility problem for the Fed, as pre-meeting communications had pointed toward a smaller 25 bps cut. This deviation, in BofA's view, left the Fed vulnerable to market pressures for further cuts.

Hawkish Tone in Powell’s Press Conference

Chair Powell's press conference reinforced the Fed’s hawkish tone, with a focus on recalibrating policy rather than signalling future cuts. Powell indicated that the market should not expect further 50 bps cuts in the near term, reiterating that the Fed’s primary goal was to bring rates to a neutral level.

While Powell acknowledged that the labour market had softened, he stressed that further cooling was not necessary to bring inflation down to the 2% target. Interestingly, Powell referenced a revision to employment data that showed 818,000 fewer jobs than previously reported, though he noted that this revision would not directly influence future policy decisions.

Further Rate Cuts Likely 

Despite the Fed’s attempt to project confidence, BofA maintained that deeper rate cuts would be needed. In BofA's assessment, the labour market is likely to remain weak, pushing the Fed to deliver another sizable cut in the fourth quarter. The investment bank projected an additional 75 bps of cuts in 2024 and 125 bps in 2025, resulting in a terminal rate of 2.75-3%.

BofA also pointed out that long-term yields rose slightly following the Fed meeting, suggesting that the central bank’s "recalibration" had not achieved its desired effect. BofA concluded that unless economic data remained consistently strong, the Fed would be forced to abandon its hawkish stance and implement further cuts.

In summary, while the Fed sought to present its recent 50bp rate cut as a mere adjustment, BofA predicted that economic conditions would force the central bank into a more aggressive series of cuts over the coming quarters.

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