Two Roller Coaster Rides in One Week

In the recent policy meeting, the Federal Reserve decided to hold steady, maintaining the policy rate range of 5.25%-5.5%. Powell emphasized that the inflation data so far this year is not sufficient to give the Fed confidence to cut rates; more data is needed to boost confidence. This indicates that the Fed remains uncertain about the path of interest rate policy.

In just one week, the market has experienced two rounds of roller coaster rides, from an unexpectedly strong ADP employment report to the overnight non-farm payroll data that shattered confidence, and then from the favorable CPI data to the Fed’s dampening remarks.

The 10-year Treasury yield has also been volatile, with the latest yield approaching its lowest level since April. The Fed stated that the cautious decision-making is due to the moderate decline in inflation data and a cautiously optimistic outlook for the economy.

May’s data showed that CPI year-over-year fell to 3.3%, below the expected 3.4%, with a month-over-month growth of 0.0%, below the expected 0.1%.

Core CPI also fell to 3.4% year-over-year, below the expected 3.5%, with a month-over-month growth of 0.2%, below the expected 0.3%.

From a detailed perspective, the drop in oil prices in May had the most significant impact on CPI, with energy falling 2.0% month-over-month, while housing remained flat at 0.4% month-over-month. Rent and owner’s equivalent rent (OER) continued to be sticky. Notably, super core services inflation was -0.04% month-over-month, marking the first negative growth in three years, mainly due to declines in transportation and recreation. However, there is concern that summer travel could cause this portion of inflation to rebound.

Will Rate Cuts Begin in September?

The dot plot shows that out of 19 voting members, 7 believe there will be one rate cut this year, 8 believe there will be two cuts, and no one expects three cuts this year.

On the other hand, market participants’ pricing indicates a 66.7% probability of the first rate cut in September, with at least two cuts this year having a 68.5% probability.

Will the Rate Cut Come During the Election Period?

There are many conservative views in the market. Analysts from Bank of America and Deutsche Bank predict only one rate cut this year. They point out that if inflation data continues to moderate in the coming months, and economic growth and the labor market slow down simultaneously, the Fed might cut rates in December.

Deutsche Bank believes that Powell mentioned that rate decisions are not only based on inflation but also on “overall data,” including labor market and economic growth data. “If inflation progresses significantly but the labor market and economy continue to perform strongly, the Fed may choose to keep rates unchanged for a longer period.”

In a “range of broad indicators,” which have shown clear signs of balance, Powell noted that the unemployment rate is still at “historically low levels,” with an average of 218,000 jobs per month in April and May being “still strong,” and wage growth still exceeding the level consistent with 2% price inflation.

What scenario would push the Fed to cut rates before the election? Deutsche Bank believes that it requires continued moderate inflation data in the coming months, along with simultaneous slowdowns in economic growth and labor market data. If these conditions are met, an earlier rate cut is also possible.