Bank of America announces huge shift in Fed rate cut forecast

The jobs market is struggling this year as companies cut costs to offset the Trump admnistration's steep tariffs and government employment resets to reflect austerity stemming from DOGE-cuts earlier this year.

The weakness is evident across many measures, including layoffs and hiring.

• The unemployment rate has increased to 4.3% from its 3.4% low in 2023, according to the Bureau of Labor Statistics.
• Layoffs year-to-date through August total 892,362, up 66% year over year, according to Challenger, Gray & Christmas.
• Only 7.2 million open, unfilled jobs were available nationwide in July, down from over 12 million in 2022.

The data suggest that the Federal Reserve will lower interest rates, given that low unemployment is one of its mandates, but not everyone believed cuts would happen this year — until now.

Bank of America has been steadfast in forecasting that the Federal Reserve will remain on the sidelines through 2025 because of inflation risks. However, following the BLS's latest unemployment report for August, its analysts have changed their tune.

Bank of America predicts rate cut in September

Since summer 2024, the U.S. unemployment rate has been range-bound between 4% and 4.2%. However, that range was broken on Sept. 5, when the August jobs data landed, showing unemployment rose to 4.3%.

That's the highest reading since October 2021, when it clocked in at 4.5%. The trend higher this year isn't likely lost on the Federal Reserve.

The Fed is governed by a dual mandate:

• Low unemployment.
• Low inflation.

It's not as simple as it sounds. The Fed indirectly controls the interest rates banks charge on loans by adjusting the Federal Funds Rate, the rate at which banks lend each other reserves overnight.

The problem, however, is that lower rates reduce unemployment and increase inflation, and vice versa.

The mandate's contradictory nature means the Fed often finds itself behind the curve when setting monetary policy, waiting to ensure that it doesn't cause one problem while trying to fix another.

For this reason, Fed Chairman Jerome Powell has kept rates unchanged this year, worried that reducing them could fan inflationary flames even as the full impact of tariffs lands.

There's certainly evidence that he's not wrong about inflation, given the Consumer Price Index has risen to 2.7% from 2.3% since April, when most tariffs were announced.

CPI inflation since April:

• July: 2.7%
• June: 2.7%
• May: 2.4%
• April: 2.3%

Source: Bureau of Labor Statistics

That argument has been a big reason Bank of America has maintained its outlook for no rate cuts in 2025 until now.

After the unemployment rate reached a new cycle high in August, B of A's analysts now say that the Fed's hands will be forced, resulting in a 0.25 percentage point cut to the Federal Funds Rate on Sept. 17, when the central bank's policy-making Federal Open Market Committee next meets:

“The [August] jobs report should cement a shift in the Fed's thinking from worrying about inflation to focusing on labor weakness. ... We now expect the Fed to cut by 25 basis points each in September and December,” wrote the analysts in a research note shared with TheStreet.

“It's not surprising that B of A is evolving its thinking on rate cuts following the softening in August job creation noted from multiple sources, not just the August employment report,” TheStreet Pro's veteran fund manager Chris Versace said.

“The question now, in the face of elevated inflation data, is: How many rate cuts might the Fed deliver this year? Next week's August CPI and PPI may help us sort that out.”

According to CME Group's popular tool, the probability of a quarter-percentage-point rate cut in September is 88%, and chances for a half-point cut have climbed to 12% from 0% on Sept. 4, before the unemployment report release.

More rate cuts could be coming through 2026

Bank of America doesn't think the Fed will take a one-and-done approach to lowering interest rates.

More Economic Analysis:

• Fed official sends bold 5-word message on September rate cuts
• New inflation report may have major impact on your wallet
• Surprising GDP report resets backdrop for stocks

The investment firm says a rate cut is “on the table” for October, but that's not the base case. Instead, it models two cuts in 2025, followed by even lower interest rates in 2026.

The analysts expect Powell and company to lower interest rates by half a percentage point in 2025, followed by another 0.75 percentage point next year, bringing the rate to a range of 3% to 3.25%.

That would mean a total 2.25 percentage points of rate cuts from the peak Federal Funds Rate last year, including 1 point of cuts at the end of 2024.