The divergence within the Federal Reserve (FED) is historically rare.

Deutsche Bank said the June dot plot reflects a 10-year high of divergence among Fed officials as they have fundamental differences on how to balance inflation control with economic growth.

Written by: Li Xiaoyin

Source: Wall Street View

The Federal Reserve's internal divisions reach a ten-year high, what are the prospects for interest rate cuts?

The latest economic forecast summary (SEP) released by The Federal Reserve (FED) shows that the median expectation for interest rate cuts in 2025 has reached 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 importantly, Federal Reserve governors Waller and Bowman were the first to "switch sides" and publicly stated 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 news from the Chasing Wind Trading Platform, 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 among officials on how to balance inflation control with economic rise.

The report also added that, although the current divergences are significant, the uncertainty among Federal Reserve officials regarding the interest rate path for 2025 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 gradually converge, but divergences will still persist in the short term.

The Federal Reserve (FED) experiences historic internal divisions, but the uncertainty around interest rates 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 "historical uncertainty" but rather "historical division."

According to Deutsche Bank's research, the dot plot from June shows a highly polarized distribution among Federal Reserve officials regarding their predictions for the federal funds rate in 2025, with a gap of 50 basis points between the most common and the second most common predictions, 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 (FED) has split into two major factions.

The report indicates that the extent of this divergence suggests that there may be more debates or even dissent within the committee in the coming months.

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

Measured by the difference between the maximum and minimum values of the dot plot, the dispersion of the June SEP is comparable to the mid-term forecasts of many years 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 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 on the unemployment rate outlook, with a divergence of only 0.3 percentage points.

Economic Outlook and Inflation Risks

The internal divisions within the Federal Reserve stem from different interpretations of the economic fundamentals.

The report indicates that although there is high uncertainty regarding inflation, there is a strong consensus among officials about the outlook for the unemployment rate, which may have suppressed further divergence in interest rate forecasts.

However, the dual peak distribution of the policy path in the June dot plot indicates a fundamental divergence among officials on how to balance inflation control and economic rise. The open attitude 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 the current economic slowdown, while others are more focused on the persistence of inflation.

Looking ahead, it remains unclear whether the internal divisions within the Federal Reserve (FED) will evolve into actual policy disagreements. The report anticipates that as economic data becomes clearer, officials' views may gradually converge, but disagreements are likely to persist in the short term.