Keeping the Landing Soft

The Fed’s choice of starting its easing process with a 50bps cut is bold, but the new forecasts associated with the policy decision make it plain that, according to the FOMC, a total of 200bps worth of cuts is what could be needed to “keep the soft landing soft”, which is clearly what the central bank is focused on, now that it deems the inflation battle won. As an – important – aside, the FOMC believes that, probably partly because it chose to “start with a bang”, it won’t have to take policy rates into properly accommodative territory in this cycle. Indeed, we do not think it is a pure accident that the level at which the Fed Funds rate lands at the end of 2026 coincides with their new estimate of its “long-run level”. We think it is an important clue the bond market should not miss. 

Now, a central bank’s forecasts should be received more as a “statement of intent” than as a proper “plan of action”. In retrospect, the June dot plot was too hawkish, over-reacting to the rebound in services inflation in early 2024. Symmetrically, the September one may be overly reactive to the disappointing payroll prints of the summer. To gauge the probability of the latter materialises, and to characterise the contrast with the ECB, we look into some of the missing information in the Fed’s decision function. A lot will depend on the outcome of the elections in November, and we think the Fed may have to reserve judgement on the quantum of cuts it should still provide if Donald Trump is elected. Conversely, we think that the outlook is clearer on the Euro area side. The only factor which could support the hawkish case are the lingering adverse developments on labour supply, reflected in the still high level of hiring difficulties reported in the business surveys. We offer a quantification of their impact on wage developments, and find that they played a visible role, but not a crucial one, in the pay developments of the last two years, opening the door to a continuation of the wage deceleration despite a still constrained labour supply. Given the external conditions, and the perspective of fiscal retrenchment next year – more certain, in terms of direction of travel, than in the US – the ECB may well be forced into an acceleration of its easing effort. We would be back to the “mirror risk” which we highlighted at the beginning of this year: the possibility the Fed would end up “doing too much”, and the ECB “too little”, at least initially