The Federal Reserve will announce its July interest rate decision at 2 a.m. Beijing time on Thursday. Although some economists say this month is the best time to start a rate cut, financial market participants believe the probability is almost zero, and the Federal Reserve is expected to pave the way for a rate cut in September by revising its statements on inflation, employment, and forward-looking guidance.
Recent US economic data is encouraging, with price increases slowing and the job market cooling, but economic growth remains strong. However, the Fed still wants to further confirm that inflation can continue to fall to its 2% target. The risks to the Fed's two missions of maximizing employment and stabilizing prices have become more balanced. Officials want to curb inflation, but they also don't want to keep high interest rates for a long time, which would cause unnecessary damage to the labor market.
The probability of a rate cut in July is almost zero
The target range for the federal funds rate is currently between 5.25% and 5.5%, and the Fed last raised rates in July 2023. Most economists surveyed by FactSet expect the Fed to keep interest rates unchanged until its September meeting.
U.S. inflation continues to cool, indicating that the price increases of goods and services have gradually slowed since their peak in 2022. At the same time, the Federal Reserve is closely watching the employment data. There are signs that U.S. employment is cooling, just as the Fed hopes. In the past three months, the United States has added an average of 177,000 jobs per month, which is stable but far lower than the 275,000 a year ago. In addition, the unemployment rate rose to 4.1%, the highest since November 2021.
Powell and other Fed officials have stressed that they are concerned almost as much about slowing employment as they are about inflation. The Fed’s gradual shift to ensuring the job market doesn’t weaken too much has boosted expectations for rate cuts and led some economists to argue that the Fed would be making a mistake by delaying a rate cut until September.
However, Peter Hooper, vice chairman of research at Deutsche Bank, believes it would be prudent to wait until September to start the easing cycle. He said that even if the labor market weakens faster and more than expected, the Fed can return to the "neutral" policy setting "fairly quickly."
“Job growth has been trending downward, and as Chairman Powell has noted multiple times over the past month, further slack in the labor market would be unwelcome,” Goldman Sachs economist David Mericle said in a note, noting that an early rate cut could help ensure the job market remains stable.
Jacob Channel, chief economist at LendingTree, said: "It now appears that a small 25 basis point rate cut may be possible in September. If all goes well, we may even see the Fed cut interest rates twice more by 25 basis points each before the end of 2024." But he warned, "However, rate cuts are far from a done deal. Remember, the Fed's goal is to quickly adjust its policies when unexpected situations occur."
Just over half of economists predict the Fed will cut its benchmark interest rate to a range of 4.5% to 4.75% by the end of the year, according to FactSet.
A change in wording hints at an impending rate cut
Although there is a high probability that there will be no interest rate cut in July and the interest rate decision seems dull, this meeting will provide important preparation for the monetary policy shift in September.
"The Fed is moving closer to a rate cut, and this week's communication should reflect that," said Brian Sack, head of macro strategy at Balyasny Asset Management and former head of the New York Fed's market group. "There is clear evidence that inflation is finally under control after many fits and starts, making officials more receptive to the idea of a rate cut."
So far, Powell and other officials have refused to make a clear statement on the timing of the first rate cut, instead saying they will make a decision based on the latest data at future meetings. Analysts believe this meeting may be different, and the Fed may hint at an upcoming rate cut by changing the wording in its policy statement and press conference.
Back in June, the Fed said it had made “modest further progress” toward 2% inflation but remained “highly focused on inflation risks.” In addition, it has long said it does not believe it would be appropriate to cut rates until it “gains greater confidence” that inflation is “sustainably” moving toward its goal.
Economists expect the Fed to acknowledge at this meeting that more progress has been made on inflation, with its preferred PCE inflation measure currently hovering at 2.6%, well below its 2022 peak.
They also believe that the policy statement will emphasize that rising inflation is not the only risk facing the Fed as the labor market has begun to weaken, and that the risks to the dual mandate are becoming more balanced.
At Powell's press conference at 2:30 a.m., he is expected to reiterate his confidence in the process of inflation falling, emphasize that cutting interest rates too early and too late are risks, but may continue to avoid pre-committing to specific policy actions. During the Q&A session, Powell may elaborate on the latest position of Fed officials on rate cuts.
Although the Fed may hint at a rate cut in September, the market has already digested a more aggressive easing path. For U.S. stocks, the next few months may still be volatile. In the years of the U.S. election, U.S. stock indexes usually rise in early August and then fall back during September and October. The Fed's rate cut may bring a short-lived rebound, but given the market's widespread expectation of a rate cut, this optimism may not last.
In addition, even if the Fed cuts interest rates, the dollar's downside is unlikely to be significant. The possibility of a rate cut in September has been fully priced in by the market, and given the uncertainty of the inflation outlook, the Fed's dovish comments may be in "short supply", which may re-boost the dollar in the short to medium term.