Deutsche Bank stated that the degree of divergence among Federal Reserve officials reflected in the June dot plot has reached a ten-year high, as they have fundamental disagreements on how to balance inflation control with economic growth.
Written by: Li Xiaoyin, Wall Street Insights
The Federal Reserve's internal divergence reaches a ten-year high; what are the prospects 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' predictions varies from no cuts to a reduction of 75 basis points, highlighting significant differences among policymakers.
More critically, Federal Reserve governors Waller and Bowman were the first to "defect," publicly stating that they do not rule out the possibility of a rate cut in July, which further intensified 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 divergence among officials reflected in the June SEP report has reached a ten-year high, due to fundamental disagreements on how to balance inflation control with economic growth.
The report also noted that although the current divergence is significant, the uncertainty regarding the interest rate path for 2025 among Federal Reserve officials is not unprecedented and is even lower than the levels seen at the same time last year. It is expected that as economic data gradually clarifies, officials' views may converge, but divergences will persist in the short term.
Historic Divergence Within the Federal Reserve, but Interest Rate Uncertainty Actually Decreases
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 a highly polarized distribution of Federal Reserve officials' predictions for the federal funds rate in 2025, 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 historical records, indicating that the Federal Reserve has split into two major camps.
The report states that this degree of divergence suggests that there may be more debates or even dissent within the committee in the coming months.
Although the current divergence is significant, the report shows that the uncertainty regarding the interest rate path for 2025 among Federal Reserve officials 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 many mid-term predictions over the past decade, and even lower than the levels seen in June 2023.
In terms of inflation predictions, although the divergence among officials regarding core PCE inflation has reached the highest level in the past decade at 1 percentage point, this has not translated into historic divergence in expectations for the federal funds rate. This is partly due to officials having a relatively consistent view on the unemployment rate outlook, with a divergence of only 0.3 percentage points.
On Economic Outlook and Inflation Risks
The divergence within the Federal Reserve stems from different interpretations of the economic fundamentals.
The report points out that although inflation uncertainty is high, there is a strong consensus among officials regarding the unemployment rate outlook, which may have suppressed further dispersion in interest rate predictions.
However, the bimodal distribution of the dot plot regarding the policy path indicates that there are fundamental disagreements among officials on how to balance inflation control with economic growth. The open attitude of Governors Waller and Bowman towards a rate cut in July further highlights this divergence, possibly reflecting concerns among some officials about the current economic slowdown risks, while others are more focused on the persistence of inflation.
Looking ahead, it remains unclear whether the internal divergence within the Federal Reserve will evolve into actual policy dissent. The report anticipates that as economic data gradually clarifies, officials' views may converge, but divergences will continue in the short term.
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