Investing.com - Investors are widely betting that the Federal Reserve will cut interest rates at its next meeting in September, especially after data earlier this week indicated potential subdued inflationary pressures.
The growth of core consumer prices in the United States was slower than expected year-on-year in July, encouraging bets that inflation in the world's largest economy has not yet been reignited by comprehensive U.S. tariffs. However, producer prices rose at a faster rate than expected, with the cost of services rising particularly.
However, the weak jobs report for July, which also came with sharp downward revisions to employment additions in June and May, is at the core of the case pushing the Fed to cut interest rates next month.
After the release of the non-farm payrolls report, many policymakers at the Fed hinted at a greater willingness to support a rate cut, rather than sticking to their 'wait and see' approach that has lasted for several months regarding future policy decisions.
Previously, their main concerns were that President Donald Trump's aggressive trade agenda could lead to rising inflation and impact broader economic activity. But with the labor market potentially starting to slow down and consumer price gains remaining lukewarm, investors are betting that the Fed may have more room to cut interest rates without unleashing a wave of inflation. In theory, a rate cut could encourage companies to spend and invest in hiring.
The Fed will have another report on non-farm payrolls and inflation to study before its meeting on September 16-17.
In a note, analysts at Capital Economics said that a quarter-point cut by policymakers "has now largely been priced in the markets," meaning that Treasury yields are likely to rise if the Fed does not deliver the cut. This could put pressure on companies by reducing the present value of their future earnings.
"However, even if Treasury yields rise, the problem with the simplistic argument is that it ignores the potential effects of the [Federal Open Market Committee's interest rate-setting decision] and related communications on risk appetite and growth expectations, both of which often have a larger effect than Treasury bonds on stock prices," said Capital Economics analysts led by John Higgins.
Analysts added that they expect S&P 500 earnings yield to continue to decline, while earnings per share growth is to continue over the next twelve months, feeding their expectations that the benchmark index will rise to 6,750 and 7,250 by the end of 2025 and 2026, respectively. On Friday, the S&P 500 closed at 6,449.80.
Analysts said, "We won’t feel the need to revise these forecasts down if the Federal Open Market Committee fails to cut interest rates next month, provided that its main justification is ongoing concern about rising inflation."
"But we also won’t feel the need to revise forecasts higher even if it starts to ease policy again due to concerns about the economic outlook primarily."