What To Expect From Fed's July Meeting?

As the Federal Reserve is set to hold its first interest rate meeting of the second half of the year this Wednesday, a key meeting that may signal whether there will be a rate cut in September, it has undoubtedly attracted almost every bit of market attention.

Now, the biggest question at the Fed's meeting on Wednesday is how strong the signal for a rate cut will be from the officials. It is widely expected that the Fed will keep the benchmark interest rate at 5.25% to 5.5% this week, the highest level in more than two decades, but it is also expected to prepare for a series of rate cuts at the next meeting in mid-September.

What Criteria Have the Officials Set For A Rate Cut in September? 

Voices are suggesting that officials are expected to revise the post-meeting statement - implying that the possibility of a rate cut in September is greater than not cutting. Members of the Federal Open Market Committee, which is responsible for setting interest rates, are expected to have a heated debate on the policy statement.

Economists believe that the Fed's acknowledgment of recent improvements in inflation and a more balanced risk and any revisions to forward guidance will set the stage for Powell's press conference. At the press conference, Powell can provide more details on how officials view the issue of rate cuts.

Some analysts have already believed that Powell will open the door to a rate cut in September but will not make explicit commitments. Former senior Fed advisor William English said, If there are no major issues around inflation news between now and September, then they can say, 'Okay, now we are confident that we are on the right track, and we are going to start cutting rates.'

Why Are Officials Closer to A Rate Cut?

Earlier this year, Fed officials considered cutting rates based on good news on inflation. However, the stronger-than-expected inflation data in February and March this year made these (rate cut) plans ultimately fail.

But recently, the US inflation rate has been lower than expected. In addition, there are signs that the degree of economic slowdown may exceed expectations - especially when the real estate market is struggling.

Former Reserve Bank of India Governor Raghuram Rajan said, The Fed knows the medicine it's administering is the right one - some weaker parts of the economy are slowing down, even though there is still strength in other parts.

There will be a temptation to say, 'Well, if we really want a soft landing, we should start cutting now because we have been in the restrictive mode for some time,' and even after the Fed cuts, the policy may remain restrictive, Rajan added.

Why Not Cut Rates Now? 

Many former Fed officials and private sector economists have recently said that all the reasons for a rate cut in September - including better inflation news and signs of slowing spending and hiring - also apply now, which means the Fed should cut rates on Wednesday.

However, despite this, many Fed officials still admit that they are not confident that the inflation rate can reach the 2% target on a lasting basis. Powell pointed out after the Fed's June meeting that the first rate cut will be a significant decision that needs to make the right decision.

In this regard, regardless of the pros and cons of a rate cut in July, most Fed officials have previously stated that there is no need to rush to cut rates at present. According to a professor at Yale School of Management, an unexpected rate cut in July looks panicky, and I think it's likely to be unhelpful.

What Happens After the First Rate Cut? 

Powell may not be able to talk about what will happen after the first rate cut at the press conference, but the discussion around this topic may be an important part of the officials' private discussions this week because once the policymakers start the first rate cut, they will inevitably face more questions about when to cut rates again.

Since last year, the Fed officials' quarterly economic forecasts (dot plot) have made predictions about the interest rate prospects, indicating that once they take the first action, they will cut rates about once every quarter - each by a quarter of a percentage point.

Fed officials will not release a new dot plot this week, but they will make a new quarterly update in September, which may allow them to show whether the above predictions are still reasonable. Of course, if the labor market is weaker from now until September, officials may take consecutive actions at the initial few meetings. The Fed will hold interest rate meetings again in November and December.

Richard Clarida, who served as the Fed's vice chairman from 2018 to 2022 and is now a senior advisor at Pimco, said, If they have enough confidence to go in September, then that's got to make November live as well as December.

Of course, an awkward complex factor facing the prospects of subsequent rate cuts is that the Fed's monetary policy meeting in November will start the day after the presidential election on November 5. Although the Fed has made monetary policy adjustments before and after the election in the past, officials will try to remain apolitical when making decisions. This requires them to be clearer, more predictable, and more thoughtful in their public communications.