The Fed's next move will be to cut rates as the drop in inflation was a 'gamechanger,' former PIMCO chief economist says

• The Fed's next rate move will be to cut rates, former PIMCO chief economist Paul McCulley said.
• McCulley pointed to the drop in shelter prices, which has kept inflation stubbornly high for the past year.

The Federal Reserve's next rate move will be a cut, as the drop in inflation seen in October was a "gamechanger" for central bankers, according to former PIMCO chief economist, Paul McCulley.

McCulley in an interview with CNBC pointed to the deceleration in inflation seen last month, with the Consumer Price Index cooling to 3.2% on an annual basis. That's lower than the expected 3.3% — a major victory for the Fed, which has raised interest rates aggressively over the past year to get a grip on surging prices.

Most significant is the "crack" in shelter inflation, McCulley said, which rose 6.7% year-over-year in October. That's a slower pace than the 7.2% growth recorded in September — which is good news for prices overall, as shelter was the largest contributor to price increases in September.

"I think this is a gamechanger. We're having a day of rational exuberance because the data clearly show what we've been waiting for, for a long time," McCulley told CNBC. "I think it leads to the Fed now being comfortable declaring that policy is sufficiently restrictive, and that's a big deal, because it means they've finished tightening, and the next move will be an ease."

Investors will debate over when the Fed will cut rates, he added, though most are expecting the first rate cut to happen sometime next year. Markets are pricing in an 85% chance rates will be lower than their current level by June 2024, according to the CME FedWatch tool. UBS, meanwhile, predicted the Fed could slash rates at least 275 basis-points by the end of next year as it switches to "full-on accommodation" mode.

Lower rates spell good news for stocks in particular, which were weighed down heavily last year as the Fed began its series of aggressive interest rate hikes. A pivot to rate cuts could spark a new bull run for equities, market experts have predicted.

Some economists, though, have cautioned that the Fed risks easing interest rates prematurely, which could eventually lead to a resurgence in inflation down the line. That could potentially cause consumer inflation expectations to spiral out of control, slamming the economy with a stagflationary crisis, according to economist Mohamed El-Erian.