The divergence within the Federal Reserve is historically rare!

The Federal Reserve's internal divisions reach a decade high, what is the outlook for interest rate cuts?

The latest Summary of Economic Projections (SEP) released by the Federal Reserve shows that the median expectation for interest rate cuts in 2025 is two times, but the range of officials' forecasts varies from no cuts to a reduction of 75 basis points, highlighting significant disagreements among policymakers.

More critically, two Federal Reserve governors, Waller and Bowman, have taken the lead in “defecting”, publicly stating that they do not rule out the possibility of a rate cut in July, further intensifying market speculation about a policy shift.

According to reports from the trading desk, Deutsche Bank's chief U.S. economist Matthew Luzzet and his team stated in their latest research report that the degree of disagreement among officials reflected in the June SEP report has reached a ten-year high, as officials have fundamental disagreements on how to balance inflation control with economic growth.

The report also adds that although the current disagreements are significant, the uncertainty among Federal Reserve officials regarding the interest rate path in 2025 is not unprecedented and is even lower than the level of the same period last year. It is expected that as economic data gradually clarifies, officials' views may converge, but disagreements will persist in the short term.

Historic divisions within the Federal Reserve, but interest rate uncertainty has actually decreased

Through an in-depth analysis of the Federal Reserve's June SEP report, Deutsche Bank believes that the main issue currently facing the Federal Reserve is not "historic uncertainty," but rather "historic division."

According to Deutsche Bank's research, the June dot plot shows that Federal Reserve officials' predictions for the federal funds rate in 2025 exhibit a highly polarized distribution, with the gap between the most common and the second most common predictions reaching 50 basis points, the highest level in the past decade.

The report further points out that when weighted by the number of officials, this bimodal distribution is close to a historical record, indicating that the Federal Reserve has split into two major camps.

The report states that this level of disagreement suggests that there may be more debates or even dissent within the committee in the coming months.

Despite the current significant disagreements, the report shows that the uncertainty among Federal Reserve officials regarding the interest rate path in 2025 is not unprecedented.

Measured by the difference between the maximum and minimum values in the dot plot, the dispersion of the June SEP is comparable to that of many mid-year predictions over the past decade, and even lower than the level in June 2023.

In terms of inflation forecasts, although the divergence among officials regarding core PCE inflation has reached the highest 1 percentage point in the past decade, this has not translated into a historic divergence in expectations for the federal funds rate. This is partly due to the relatively consistent views among officials regarding the unemployment rate outlook, with a divergence of only 0.3 percentage points.

Economic Outlook and Inflation Risks

The divergence within the Federal Reserve stems from different interpretations of the economic fundamentals.

The report notes that despite high inflation uncertainty, there is a strong consensus among officials regarding the unemployment rate outlook, which may have suppressed further dispersion in interest rate forecasts.

However, the bimodal distribution of the policy path in the June dot plot indicates a fundamental disagreement among officials on how to balance inflation control with economic growth. The open stance of Governors Waller and Bowman towards a rate cut in July further highlights this divergence, potentially reflecting concerns among some officials about the risks of a current economic slowdown, while others are more focused on the persistence of inflation.

Looking ahead, it remains unclear whether the divergences within the Federal Reserve will evolve into actual policy disagreements. The report anticipates that as economic data gradually clarifies, officials' views may converge, but divergences will persist in the short term.