Federal Reserve watchers are placing their bets on the central bank using its upcoming July meeting to prepare the groundwork for a potential interest rate cut in September. Although few expect a policy change this week in Washington, D.C., many believe the Federal Reserve will signal its readiness for a significant policy shift in the near future.
Federal Reserve officials have recently expressed increased confidence in the prospect of inflation stabilizing at their 2% target. Additionally, they have voiced concerns about rising unemployment, suggesting that a rate cut may be on the horizon. Despite this, most experts agree that the Fed requires a bit more time to ensure the economy’s trajectory before making such a move.
“The pressure is growing for them,” said Esther George, former Kansas City Fed president. “I think that they are going to look at September very seriously. It’s looking to me like we are coming to a time where that decision is more important and it’s why I’m more confident.”
The core Personal Consumption Expenditures (PCE) index, the Fed’s preferred inflation gauge, showed its lowest annual gain in over three years, providing some assurance that a rate cut could be approaching. The PCE index rose by 2.6% annually in June, maintaining the same level as May and down from 2.8% in April. On a three-month annualized basis, core PCE dropped to 2.3% from 2.9%.
Similarly, the Consumer Price Index (CPI) also indicated progress. Excluding volatile food and energy prices, core CPI rose by 3.3% year over year in June, down from 3.4% in May and 3.6% in April.
At the conclusion of this week’s policy meeting, Wilmington Trust chief economist Luke Tilley expects the Fed to convey that recent economic data, particularly inflation figures, have bolstered their confidence in achieving their inflation target, thereby justifying a potential rate reduction soon.
Some Fed observers argue that there is already sufficient economic data to support a rate cut this week, although they acknowledge it is unlikely. “I don’t see a reason within the economic data that they should not cut this meeting,” Tilley said. “In fact, I think it’s hard to see a reason that they should keep rates where they are.”
Despite this, Tilley notes that a rate cut this week would likely shock the markets. He predicts a rate cut in September and another in December, followed by six quarter-point cuts throughout 2025.
Goldman Sachs chief economist Jan Hatzius also sees a solid rationale for a July cut. “If the case for a cut is clear, why wait another seven weeks before delivering it?” Hatzius said in a research note. He cautioned that the volatile nature of monthly inflation poses a risk of a temporary re-acceleration, making a September cut potentially awkward to explain. A July cut would mitigate this risk.
Nonetheless, many Fed officials have indicated they need more than one quarter’s worth of positive data to confirm that inflation is heading in the right direction. They may prefer to wait for July and August readings before making a final decision.
“I do think they’re going to strain hard to say September is probably the time, but they’re going to have to be careful with their language so they don’t commit without seeing the August data,” George said.
Another significant factor influencing the timing of a rate cut is the cooling labor market. The unemployment rate has risen for two consecutive months to 4.1%, exceeding some Fed officials’ year-end predictions. The Fed’s dual mandate requires it to balance maximizing employment with maintaining stable prices. As inflation declines, Fed Chair Jerome Powell has emphasized the central bank’s increased focus on the labor market.
Chicago Fed president Austan Goolsbee highlighted concerns over the cooling job market, noting it as an area to watch. While other warning signs exist, Goolsbee suggested the current situation reflects a labor market returning to balance rather than the onset of a recession.
Tilley anticipates the unemployment rate will rise to 4.5% by year-end as more individuals enter or re-enter the job market, and others lose jobs. However, George remains skeptical of a soft landing, predicting an eventual recession. She pointed to the declining momentum of new job market entrants as a sign of an impending slowdown.
Political pressures also loom over the Fed’s decision-making process. A September rate cut could provoke criticism from both sides of the aisle. Democrats may push for rate cuts, while Republicans, including Donald Trump, could accuse the Fed of succumbing to election-year pressures.
As the Fed navigates this complex landscape, its actions this week are unlikely to pose significant economic risks, provided they signal a rate cut for September. This expectation should help adjust government bond yields and borrowing rates accordingly.
Key Takeaways:
- Investors anticipate the Fed will prepare for a September rate cut during the July meeting.
- Recent economic data, including the PCE and CPI indices, indicate progress toward the Fed’s inflation target.
- Some experts argue for an immediate rate cut, though this is deemed unlikely to avoid market shock.
- A cooling labor market and political pressures add complexity to the Fed’s decision-making process.
