Fed’s Mester says markets are a ‘bit ahead’ of central bank on rate cuts

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A top official at the Federal Reserve has warned that financial markets had jumped “a little bit ahead” by pencilling in early interest rate cuts next year, the latest attempt by the US central bank to rein in the exuberance that has driven up stocks and bonds globally.

Loretta Mester, president of the Cleveland Fed and a voting member on the Federal Open Market Committee next year, pushed back on expectations that the central bank will abruptly pivot towards lowering borrowing costs now that it is more confident it has lifted its benchmark interest rate to a level restrictive enough to get inflation under control.

Her comments align with those from two other 2024 voting FOMC members — John Williams of the New York Fed and Atlanta’s Raphael Bostic — who on Friday stressed rate cuts were not imminent.

Mester told the Financial Times in an interview: “The next phase is not when to reduce rates, even though that’s where the markets are at. It’s about how long do we need monetary policy to remain restrictive in order to be assured that inflation is on that sustainable and timely path back to 2 per cent.

“The markets are a little bit ahead,” she added. “They jumped to the end part, which is ‘We’re going to normalise quickly’, and I don’t see that.”

Since the Fed’s final meeting of 2023 last week, traders in futures markets have ramped up bets that the central bank will lower its benchmark interest rate as early as March and eventually reduce it over the course of next year to just below 4 per cent from its current 22-year high of 5.25-5.5 per cent.

The catalyst was a dovish message from chair Jay Powell, who struck a confident tone about the Fed’s grip on inflation and conceded that a nascent debate was under way among officials about rate cuts.

New projections also released last week showed a majority of policymakers supported lowering the federal funds rate by 0.75 percentage points in 2024 and another full percentage point in 2025 before it falls below 3 per cent the year after.

The president of the Cleveland Fed, who is set to retire in June after a decade at the helm, told the FT she was among officials to forecast three quarter-point rate cuts next year given her prediction that inflation would continue to moderate as growth cooled further and unemployment ticked up slightly — what she said amounted to a soft landing.

That economic backdrop would require the Fed to begin “normalising policy and bringing it back to a more neutral stance over time”.

With the Fed’s policy settings now in a “good place”, Mester said officials would be conscious not to wait too long to lower interest rates such that they cause excessive job losses.

“We’re not going to be content with inflation settling in at a level above [our] goal . . . but we’re not going to ignore the maximum employment part of the mandate,” she said. “Balancing those risks is going to be important and they will change over time with how the economy is going.”

So far, there has been “discernible progress” on inflation without a sharp jump in the unemployment rate, which still hovers below 4 per cent. But Mester cautioned against “extrapolat[ing] out what we saw in the first part of getting inflation down. The dynamics in labour markets could change.”

When the time comes to discuss more actively the timing and pace of rate cuts, Mester said she would be closely watching one-year forward inflation expectations and how quickly they were moving back towards the 2 per cent target.

“If you don’t take action as expected inflation comes down, then you’re really firming policy,” she said. “You don’t want to inadvertently become more restrictive than you think is appropriate.”