The Fed (Probably) Won't Cut Rates This Year Vanguard Model Says

Many investors believe a slowing economy will force the Federal Reserve to cut interest rates later this year. That view has helped push the S&P 500 up 12% so far in 2023.

The Fed’s rate moves are important for individuals, because they influence rates for credit-card, auto, home and other personal loans.

Interest-rate futures prices indicate a 33% probability that the Fed’s federal-funds rate target will end the year below the current 5% to 5.25% range.

The Fed has lifted rates at 10 straight Fed meetings through May, and investors’ consensus is for no change at next week’s meeting.

Vanguard economists, using a machine-based model, aren’t among those who think rates are headed lower this year.

Inflation, Unemployment Forecasts

“We believe inflation will continue to moderate but remain above 3% through year-end, and unemployment will trend higher to a still reasonable 4.5%,” Asawari Sathe, Vanguard senior economist, said in a report. “In that scenario, the Fed cutting its policy rate this year is unlikely.”

Consumer prices climbed 4.9% in the 12 months through April, and unemployment totaled 3.7% in May.

Vanguard’s model doesn’t forecast a rate cut until the middle of 2024. For the Fed to pull inflation back toward its 2% target, Vanguard sees a 38% probability the Fed will lift rates in the “near future”, a 35% chance the Fed will hold steady and a 27% chance it will lower rates.

Interest-rate futures indicate a 70% probability that the fed funds rate will be higher after the July Fed meeting than it is now.

As for Vanguard’s view, “our model’s output underscores our conviction that the Fed’s fight against inflation hasn’t yet reached an inflection point,” Sathe said.

Models Have Their Limitations

Vanguard's machine-based model factors in macroeconomic and market data through May 2023. “For periods beyond that, the model uses Vanguard’s in-house views on inflation (core consumer price index), labor markets, and economic growth this year and next as inputs to generate … probabilities of the Fed’s moves.”

Vanguard offers detailed additional information about its methodology. It certainly sounds rigorous, and Vanguard is obviously full of sharp analysts. But making economic predictions is extremely difficult. Conditions can change quickly and in unexpected ways.

Something like Vanguard’s report is quite useful to let you know what some smart people – and an artificial intelligence-based model – think about the economy and Fed. 

“As with any method of prognostication, there are no guarantees,” says Vanguard itself. But its reports are still worthwhile to broaden your knowledge.