The Fed shouldn’t overlook a July rate cut, says Goldman Sachs

It’s almost a foregone conclusion that the Fed will vote to leave rates on hold at its upcoming meeting in July, but that’s a big mistake, according to Goldman Sachs.

In a note to clients, Goldman economist Jan Hatzius said inflation is moving closer to the Fed’s 2% target, which should open the door to rate cuts later this month.

“Using the latest unemployment and inflation numbers, we estimate that the median of the Fed staff’s monetary policy rules now implies a funds rate of 4%, well below the actual rate of 5.25%-5.50%,” Hatzius wrote.

“Based on this observation, the encouraging June CPI, and Chair Powell’s congressional testimony last week, we expect adjustment cuts to start soon,” he said.

But “soon” probably won’t happen soon enough. According to CME Group’s FedWatch Tool, the odds of a July rate cut are less than 7%.

Hatzius thinks waiting another two months is pointless since policymakers have all the information they need to make a decision now.

“If the case for a rate cut is clear, why wait another seven weeks before delivering it?” he wrote, referring to the September FOMC meeting, where the odds of a rate cut grow to 98%.

Fed expectations are changing

Thanks to a series of better-than-expected inflation reports, economists think multiple rate cuts are back on the table this year.

According to an updated forecast by Moody’s, interest rates are expected to fall by up to 0.75% this year before dropping by another 1% to 1.25% in 2025.

Citigroup analysts think Fed cuts will be even more aggressive. They forecast eight consecutive rate cuts, beginning in September and running through next July.

Even San Francisco Fed President Mary Daly thinks rate cuts should come sooner rather than later. In a conference call with reporters, Daly said, “I see it as likely that some policy adjustments will be warranted.”

Daly is a member of this year’s FOMC, which means she has a vote in the next four policy meetings in July, September, November, and December.

Although the Fed hasn’t specified where rates are headed, its assessment of “neutral rates” provides a clue. (Neutral rates are the point at which interest rates neither stimulate nor restrict economic growth.)

According to Fed estimates, the neutral rate is around 2.8% today or even slightly lower. Economists say that could be the Fed’s benchmark when inflation returns to target.

Even at 3%, that still leaves plenty of runway for future cuts, given that the current federal funds rate is 5.5%—the highest level in more than two decades.