Goldman expects Fed to start rate cuts in Q2 next year; funds rate seen stabilizing at 3%

investing.com:

According to Goldman Sachs, the Federal Open Market Committee (FOMC) could begin cutting the funds rate in the second quarter of 2024.

This projection is based on the expectations that the core Personal Consumption Expenditures (PCE) inflation will have dropped below 3% on a yearly basis and under 2.5% when looked on a monthly basis.

Even without a recession, the FOMC could be inspired to make the funds rate more aligned with a neutral level.

“Normalization is not a particularly urgent motivation for cutting, and for that reason we also see a significant risk that the FOMC will instead hold steady. The FOMC might not cut because inflation might not fall enough or, even if it does, because solid growth, a tight labor market, and a further easing of financial conditions might make cutting seem like an unnecessary risk,” Goldman Sachs strategists said in a client note.

Goldman disagrees with the view that the FOMC must cut rates as inflation falls to prevent real interest rates from rising and hurting the economy.

“Real interest rates should be calculated by subtracting off forward-looking inflation expectations, not realized inflation, and inflation expectations have already fallen to or nearly to target-consistent levels. Moreover, adjusting our broader financial conditions index (FCI) for inflation rather than the funds rate has very little impact on the implied impulse to GDP growth, which is now modest.”

While the investment giant is “uncertain about the pace” of rate cuts next year, it projects the Fed will deliver 25 basis points of cuts per quarter. Eventually, the funds rate should stabilize at 3-3.25%, above the FOMC’s 2.5% median longer run dot.

“We have long been skeptical that neutral was as low as widely