It is basically clear that the FOMC will not change interest rates this week. However, market participants will be keenly watching Fed announcements, on the lookout for any hints of a potential cut in September. We are anticipating two cuts of 25 bp this year: in September and December.
Key points:
- The FOMC is expected to maintain interest rates, with the chance of a cut being minimal.
- There will be no publication of a dot plot or macroeconomic projections.
- We expect Powell to emphasize progress on the inflation front.
- Powell is likely to leave the door open for a rate cut in September.
- About 2.5 rate cuts are being priced in futures contracts for this year.
- We expect two rate cuts from the Fed in 2024.
Inflation in the US is looking positive again
After a prolonged period of stagnation on the inflation front, measures of price dynamics in the US have finally returned to a downward trend. In June, inflation was lower than expected – its main measure fell to the lowest level in a year at 3%, and core inflation fell to the lowest since April 2021 at 3.3%. Our preferred three-month annualized core measure, which eliminates volatility seen in monthly dynamics, fell to 2.1% during this period, and is therefore currently just above the Federal Reserve’s 2% target.
The progress in the Fed’s preferred measure of inflation (PCE) has been similarly encouraging in recent months – its three-month annualized core measure fell from 4.8% in March to 2.3% in June. The Fed’s conviction of achieving the price mandate should also be supported by the loosening of labor market conditions. The average monthly increase in jobs slowed from 267,000 in the first quarter to 177,000 in the second. The unemployment rate reached a nearly three-year high of 4.1%, the number of new jobless claims increased, and the number of new jobs and wage dynamics decreased.
The Fed will wait until new projections before making a decision about rate changes
The phenomena mentioned should increase the certainty of the FOMC members that economic activity and price dynamics are closer to balance, and an interest rate cut will soon be justified. We have already observed the dovish turn of Fed Chairman Jerome Powell, who indicated this month that “significant progress” has been made in fighting inflation. This reinforces investor belief that Fed interest rate cuts are indeed rapidly approaching – two cuts are currently fully priced into futures contracts for this year, with a third roughly halfway.
We are almost certain that this week’s meeting will not result in interest rate changes. We justify this partly by the fact that the next quarterly economic and interest rate projections, which usually accompany significant changes to the Fed’s monetary policy, will be published in September. However, the FOMC will likely suggest in their communications that lower interest rates are in the near future.
The bank stated in June that “moderate further progress” had been made in the fight against inflation – this time we expect an assessment that the situation has significantly improved since then. Powell is likely to reinforce this message during his news conference and add that monetary policy in the US is restrictive.
We do not believe, however, that the Fed Chairman will deliver clear forward guidance regarding interest rates this week, but rather that he will leave the door open for a cut in September. Numerous important readings will be published between the upcoming meeting and the next one in September, so the Fed will refrain from making declarations until it is certain that the data is in line with its expectations. Instead, policymakers will likely emphasize progress in the fight against inflation and that decisions are being made on a meeting-to-meeting basis.
The data still suggests the first cut in September
Any dovish comments from Powell about inflation should be enough to solidify market conviction of a September move. More than a standard cut (28 pb) is currently priced into futures contracts. We believe that not enough arguments have emerged to justify delaying the Fed’s interest rate cuts. The GDP growth rate reading for the second quarter published last week surprised on the upside, showing 2.8% growth on an annualized basis versus a consensus of 2.0%. We believe that this will not be enough to change the Fed’s plans, especially considering the outdated nature of this data and recent signs of a cooling labor market, which could signal weaker economic activity.
We maintain our view that US interest rates will be cut twice this year: in September and December, when new FOMC projections will be published. A more aggressive loosening of monetary policy (68 bp by the end of the year) is being priced into futures contracts. This provides room for the dollar to appreciate in the short term, especially if Powell’s communications suggest a cautious approach to rate cuts in the coming quarters.
The FOMC policy decision will be announced on Wednesday (07.31) at 8:00 PM, and Chairman Powell’s press conference will begin 30 minutes later.
Authors: Matthew Ryan, CFA – Head of Market Analysis Ebury
