The first interest rate cut in the United States in four years is within reach. However, the market is uncertain whether it will be a move of 25 basis points or a stronger change by the Federal Reserve (Fed). The extent of the easing will not matter as much to the economy. Yet, the decision may hint to the market how the Fed evaluates the state of the economy and what it expects in the near future.
Undoubtedly, the Fed needs to start acting, as indicated by data. The inflation rate, measured by the Personal Consumption Expenditures (PCE) deflator excluding food and energy, dropped by 3 percentage points from its peak level at the start of 2022 to 2.6% currently. This trend should continue in the coming months. On the other hand, wage growth, which plays a decisive role in service prices, has also noticeably slowed down. Projections suggest that by spring 2025, core inflation will likely be just slightly above the Fed’s target of 2%. At the same time, the labor market is showing increasing signs of weakness. In the three months to August, the number of employed people increased by only an average of 116,000, compared to over 200,000 at the start of the year. Unemployment rate grew from 3.4% in April 2023 to 4.2% in August. While the situation is not catastrophic, the worsening is gradual without sudden collapses.
Currently, the Fed perceives a greater risk to employment, a part of its mandate. Previously, for a long period, the focus was on fighting inflation. This change of priorities was clearly marked during the recent central bankers’ symposium in Jackson Hole, Rocky Mountains.
September meeting is not just about the decision on the cost of money. It’s also the time for publication of updated forecasts. We will therefore get a new “dot plot”, which is likely to undergo considerable change. Recall that in June, the central bank assumed a single cut of 25 basis points this year and a total of 100 basis points cut in the cost of money for the next years (2025-2026). The current market is pricing in a total reduction of 100 basis points by the end of the year. Depending on how much the dot plot changes, the strength of the market reaction will also depend.
As I have often emphasized, a 50 basis points cut could prove to many investors that the Fed is genuinely concerned about the economy and maybe has been delaying the interest rate change for too long. Powell will probably not want to give that impression. The scope and pace of further cuts will depend on the economic data published in the coming months. The Fed will likely want to maintain a certain degree of flexibility in its actions, and the first 50 basis points change could increase pressure for further steps of the same or higher scale.
By Łukasz Zembik, Oanda TMS Brokers.
Source: https://ceo.com.pl/pierwsza-od-4-lat-obnizka-stop-procentowych-w-usa-coraz-blizej-czy-fed-zdecyduje-sie-na-25-czy-50-punktow-bazowych-25871
