Policy Signals: Fed to cut next, expected in September
3min read The Federal Reserve is gearing up for a potential 25 basis point cut to the federal funds rate this coming September.
This development, based on a recent poll of 108 economists, highlights a significant shift in market expectations, with the odds of a rate cut now exceeding 50% for the first time, as indicated by Fed Funds Futures.
Despite solid economic indicators and a rise in inflation, a majority—65 out of 108—of surveyed economists foresee a more substantial 50-basis point cut by 2024.
Investor Implications
This anticipated rate reduction signals a notable change in the Fed's policy stance, moving from hawkish to more dovish despite persistent inflation concerns. This shift suggests that the Fed might tolerate higher inflation temporarily to alleviate debt servicing pressures.
The markets have reacted to these expectations, with precious metals gaining strength, influenced by the prospect of lower interest rates. A dovish Fed, combined with inflation that is slightly above target, could support higher asset prices across the board.
The general market sentiment appears to be that unless inflation reaccelerates to concerning levels, the pause in rate hikes might be viewed favorably for risk assets.
Labor Market Data and Inflation Concerns
Recent labor market data also plays a critical role in shaping the Fed's decisions and has implications for investors. Indicators like the JOLTS report, April's jobs figures, and jobless claims have shown some weakness, potentially signaling a slowdown in wage growth and subsequent inflation.
This trend, according to the Phillips Curve, which posits an inverse relationship between unemployment and inflation, suggests that inflation could decelerate.
Investors are now poised for a pivotal week, with Fed Chair Jerome Powell's upcoming speeches and the release of Consumer Price Inflation data drawing close attention.
The impact of these events on market dynamics cannot be understated, particularly as it remains unclear whether Powell will have access to the CPI data before his speech.
Recent Fedspeak
Following Federal Reserve Chair Jay Powell's recent press conference, other Fed officials have reiterated the need for a cautious approach in monetary policy, signaling that interest rates may stay elevated for a more extended period. This careful stance is rooted in the recent uptick in inflation earlier this year and concerns about future economic conditions.
New York Fed President John Williams, along with his counterparts Neel Kashkari of Minneapolis and Austan Goolsbee of Chicago, have all advocated for a wait-and-see strategy concerning interest rate adjustments. Kashkari notably mentioned that it's more probable for rates to remain unchanged for an extended period. The Fed's decision during its May 1 meeting to maintain the benchmark interest rate between 5.25% and 5.50% aligns with this policy of caution.
In its statement, the Fed acknowledged the challenges in achieving its 2% inflation target in recent months. Investors and policymakers alike are now keenly awaiting the April Consumer Price Index (CPI) data, which is expected to show a slight improvement, with core inflation potentially decreasing to 3.6% from March's 3.8%.
Former Kansas City Fed President Esther George pointed out that the Fed would likely need three months of favorable inflation data before considering a rate cut, which could potentially happen as soon as September.
Conversely, Chicago Fed's Goolsbee expressed concerns that the spike in inflation at the year's start might suggest an overheating economy rather than a temporary anomaly.
If the inflation trend begins to show consistent improvement, it could trigger discussions about when to implement the first rate reduction. Former St. Louis Fed President James Bullard mentioned that a rate cut in December could be on the table, and even argued that a cut could be justified currently, provided that the Fed does not commit to further cuts prematurely.
Drawing parallels with the 2016 election year, when the Fed's monetary policy was also closely watched, both Bullard and George emphasized the necessity of basing decisions on solid economic data rather than external pressures like elections.
They recalled the 2016 tightening cycle, initiated under the assumption that inflation would meet the 2% target soon, a milestone that was not achieved until 2021.
Fed officials are clearly advocating for a measured and data-driven approach in their monetary policy decisions, emphasizing the need to monitor inflation trends closely before making any changes to the interest rates.
The upcoming CPI report (Wednesday morning at 8:30 a.m. ET) will be a crucial indicator for the economy's direction and will play a significant role in shaping the Fed's policy stance in the coming months. As these developments unfold, the focus on economic indicators will be more critical than ever in guiding the Federal Reserve's actions.
Conclusion
The potential for a Federal Reserve rate cut in September could significantly alter the investment landscape, potentially creating a more favorable environment for risk assets.
If inflation remains under control, the Feds dovish approach may bolster asset prices across various sectors.
Investors should therefore keep a close watch on labor market trends, upcoming inflation data, and Federal Reserve communications to strategically adjust their portfolios in response to the evolving monetary policy landscape.