Fed Officials Split on Rate Cuts Amid 11% Earnings Growth, 40% September Cut Probability

The probability of the Federal Reserve cutting interest rates in September is estimated to be around 40%, according to the president of Yardeni Research. This assessment comes as the central bank prepares to evaluate two inflation reports and one employment data set before its September meeting. The labor market is described as "extremely unstable," with initial jobless claims indicating modest layoffs but an increasing number of continued claims suggesting a prolonged job search period. This instability may prompt businesses to delay hiring plans as they assess the impact of technologies like artificial intelligence on labor demand and productivity.

In the realm of inflation, concerns persist over the sustained high levels of service sector inflation. The Consumer Price Index (CPI) and Producer Price Index (PPI) show service sector inflation rates remaining between 3% and 4%. The cessation of tariff policies has halted the decline in durable goods prices, potentially exacerbating the situation. Despite these challenges, the delay in rate cuts is seen as a positive sign, indicating economic resilience and the need to achieve the 2% inflation target before adjusting policy.

Corporate earnings have exceeded expectations, with second-quarter profits reaching a historic high, growing nearly 11% year-over-year, far surpassing the 3% market forecast. Although tariffs could compress profit margins, actual earnings data show no negative impact, suggesting that productivity gains may be higher than official statistics indicate.

Within the Federal Reserve, there is growing disagreement over the timing of rate cuts. The president of the Cleveland Fed expressed that, given the current high inflation and its upward trend over the past year, there is no justification for lowering interest rates. The president emphasized the importance of maintaining a moderate tightening stance to bring inflation back to target levels. Meanwhile, the president of the Kansas City Fed acknowledged that inflation risks are slightly higher than employment market risks but believes the current policy stance is appropriate. The president noted that recent inflation has accelerated, and businesses have been able to pass on some of the increased import costs to consumers.

The president of the Atlanta Fed also views the current policy as "slightly restrictive rather than highly restrictive." The president anticipates that the Fed will be able to lower rates to a neutral level by sometime in 2026, with only one rate cut expected this year. The president expects clearer judgments on the economic outlook later this year, with inflation remaining relatively stable between 2.5% and 2.8% over the past eight to nine months, above the Fed's 2% target. Despite the historically low unemployment rate, signs of a weakening labor market are emerging, with significant downward revisions to non-farm payrolls in May and June indicating a slowdown in job creation. The development of artificial intelligence could further reduce labor demand in real-time.

These statements come ahead of the Jackson Hole symposium, where the Federal Reserve Chair is set to deliver a highly anticipated speech. Investors will closely monitor the Chair's remarks for any hints regarding the Fed's potential actions at the September policy meeting, scheduled for September 16-17 in Washington. The Chair's comments are expected to influence market expectations and set the tone for the upcoming decision on interest rates, which will be based on the latest economic data.