In our previous discussion on the Fed, we suggested that the deterioration in the US labour market would move the Fed toward an easing path. We have now seen the Fed cut rates by 25 basis points at the September meeting. As a result, the effective Fed funds rate has fallen from 4.35% to 4.10%.
Our model of the Fed funds rate suggests that the effective rate should move toward 3.35%. At this level, the model indicates that monetary policy would be neutral.
The Summary of Economic Projections from Federal Reserve members and Fed Presidents also suggests that the Fed funds rate will fall to a similar level of 3.4% in 2026.
We believe this will happen by the end of the first quarter of 2026. In fact, the Summary of Economic Projections expects an effective rate of 3.6% by the end of 2025.
The challenge remains the gradually weakening US labour market, with unemployment expected to rise from 4.3% now to 4.5% by the end of 2025. This is then projected to fall very slowly to 4.4% by the end of 2026 and 4.3% by the end of 2027.
These expectations would suggest one of the least eventful economic cycles in recent history. We should be so lucky!
In the short term, it is likely that the Fed will cut the effective funds rate to 3.4% by March 2026.
This move to a neutral stance will have a significant effect on the world trade cycle and on commodities. The US dollar remains the principal currency for financing trade in the Indo-Pacific. Lower US short-term rates will likely generate a recovery in the trade of manufacturing exports in the Indo-Pacific region, which in turn will increase demand for commodities.
The Fed’s move to a neutral monetary policy will generate benefits well beyond the US.
