Fed Expected to Slash Rates Three Times Amid Easing Inflation and Mixed Economic Signals

Most economists now foresee the Federal Reserve reducing interest rates three times this year, marking a significant shift in financial markets. This expectation is largely grounded in the recent inflation data and mixed economic signals.
On August 14, data from the U.S. Department of Labor revealed that the Consumer Price Index (CPI) rose by 2.9% year-over-year in July, a deceleration from the previous month's 3% increase. The core CPI, excluding volatile food and energy prices, climbed by 3.2%, continuing its four-month downward trend. These figures suggest that inflationary pressures are easing, and the Fed might lower rates as soon as September, with a 25-basis-point (bps) cut looking more probable than a heftier 50-bps reduction.
Labor market indicators have injected some uncertainty, however. July's non-farm payroll data unexpectedly weakened, leading to temporary financial market disruptions. Analysts argue that the impact of weather events and other anomalies makes the data less reliable as a predictive measure for Fed policy.
Recent trends in the financial markets also underscore the likelihood of a smaller rate cut. Historical patterns show that the Fed has only opted for a 50-bps cut at the start of easing cycles when conditions were more dire, such as during the early 2000s or the 2008 financial crisis. Presently, while there was a brief correction in U.S. equities, markets quickly recovered, volatility indices stabilized, and financial conditions remained loose.
The economic fundamentals currently appear resilient enough to avert an immediate recession. Factors such as strong private sector balance sheets, steady fiscal spending, and robust corporate investment contribute to this outlook. Moreover, significant declines in asset prices, which typically signal impending recession, have not materialized.
Market reaction has been notable, especially in commodities. Gold prices surged to record highs before a brief correction, reflecting increased investor optimism in precious metals as a hedge against economic uncertainty. This move correlates with growing anticipation of lower rates, which generally weaken the dollar and boost gold prices.
Retail data supports this outlook. On August 15, the U.S. Census Bureau reported a 1% month-over-month increase in July retail sales, exceeding forecasts and marking the highest growth rate since February 2023. This increase points to continued consumer spending strength, further reducing recession fears.
Overall, economic conditions appear to validate the forecast that the Fed will commence a series of rate cuts starting in September, with 25-bps being the most logical increment. The CME FedWatch tool reflects a rising probability for this scenario, while expectations for a 50-bps cut are dwindling.
Behind these expectations, various Fed officials have also dropped hints about an imminent easing cycle, responding to inflation control and labor market stabilization. With these elements in play, most market participants are preparing for a three-step rate reduction by the year-end, aiming to bring the target rate down to around 4.25%-4.50%.