Inflation report shows Fed will cut, but question remains over how much
Ahead of this week’s inflation reports, the question was not whether the Fed was open to cutting rates, but whether it would choose to do so slowly or hastily. After the consumer price and producer price data, the issue seemed to have been cleared up a bit: Markets now see a better chance of a quarter-point cut in September, but are still weighing a more aggressive move. Comments after the second of two releases, the consumer price index, showed the Fed is still weighing variables but is more likely to start slowly. “While there is still plenty of time to prove otherwise, we do not believe today’s data suggests an urgent need for a 50 basis point cut in September,” said Lauren Goodwin, chief market strategist at New York Life Investments. “Economic momentum is slowing, but the signs that we are in a recession — such as a significant increase in jobless claims or a deterioration in the business outlook — have not yet turned red.” Taking a more cautious and less urgent approach, traders in the federal funds futures market have been pricing in about a 56% chance that the Fed will opt for a 25 basis point move at its September 17-18 Federal Open Market Committee meeting, according to CME Group. Stocks aren’t thinking much either way, either. After rising sharply on Tuesday on the back of a producer price index that rose just 0.1% in July, the major averages edged up slightly after the CPI showed a 0.2% monthly gain and an annual rate of 2.9%, the lowest since spring 2021. On the bond market, long-term yields were mostly lower, but the policy-sensitive 2-year note was little changed. US2Y .SPX 5D Yields and stocks Overall, the market is expecting the Fed to ease policy soon and start easing. Liz Ann Sonders, chief investment strategist at Charles Schwab, said the Fed is still hesitant to act, which could face a strong market reaction, but a deeper rate cut could signal darker things to come. “A more significant deterioration in the labor market than we’ve seen could trigger a more aggressive stance,” Sonders said. “Be careful what you wish for when you hope for a more aggressive Fed. History shows that a fast tapering cycle versus a slow tapering cycle is not a good cycle for stocks.” Current futures prices suggest a September cut will be followed by a 50 basis point cut in November and another 25 basis points in December. But federal funds futures have been even more volatile than usual this year, and the market now seems more concerned about the Fed’s admission that the labor market is likely to deteriorate. “I’m concerned that the Fed is basically fighting its last war,” said Tani Fukui, macroeconomist at MetLife Investment Management. “The last war against inflation was in 1980, when inflation was around 15%.” With core personal consumption expenditures heading toward 2%, “it’s a completely different world and I think we’re overthinking it,” Fukui noted the rising unemployment rate and its potential to trigger recession indicators, although she doesn’t think the economy is in a true recession. “It’s not something I would play around with for the sake of perfection on the inflation side,” she said. “A strong 50 basis point cut would help alleviate some of that pressure.”
