Why the Fed Risks Falling Behind --- Waiting until September to start cutting rates might have narrowed the Fed's room for maneuver

 

"Investors seem to have gotten very comfortable with the Federal Reserve's likely path ahead, including a rate cut in September and a couple more thereafter. What could go wrong now? Actually a lot.

The Fed tried not to tip its hand too much following its meeting on Wednesday with a statement saying risks between inflation and unemployment "continue to move into better balance." At his regular press conference, Fed Chair Jerome Powell continued to insist that future moves will be fully dependent on incoming data.

But markets appear to have made up their minds. Fed funds futures are now pricing in a 100% chance that the Fed will cut rates by at least 0.25 percentage point at the next meeting in September, including a 15% chance of a half-point cut, according to the CME Group's FedWatch tool.

What is more, markets see the Fed most likely cutting by a quarter point at each of their three remaining meetings this year, in September, November and December, with a 74% chance that the target range for rates at the end of the year will be at or below 4.50% to 4.75%, from the current range of 5.25% to 5.5%.

Investors fully embraced this scenario on Wednesday as stocks and bonds both rallied. But there are risks of complacency in two directions.

First and foremost, investors might be getting too optimistic about the outlook for rate cuts, much as they were toward the end of last year before unexpectedly firm inflation readings in early 2024 pushed back their expectations. 

It is unclear what might cause an inflation rebound this time around, but geopolitical factors are a clear candidate. The breakout of a wider war in the Middle East, for instance, could send energy prices soaring and cause broader price pressures by disrupting global supply chains.

Perhaps the bigger risk, however, is that the Fed acts too slowly to react as signs of an economic slowdown build. Anecdotes from Corporate America this earnings season have tended to suggest that things could be a bit worse on the ground than aggregate, backward-looking economic data so far suggest. McDonald's Chief Executive Chris Kempczinski, for instance, said Monday that pressures on consumers have "deepened and broadened" over the course of this year.

This risk is exacerbated by the cadence of the Fed's calendar for the remainder of the year, with no meetings in August or October. So if, for example, labor-market readings start coming in weaker for July and August and keep weakening thereafter, there could be several months of deterioration before the Fed even gets around to a second rate cut at its Nov. 6-7 meeting. Just one quarter-point cut in the interim would be unlikely to do much to arrest the slowdown, especially given the typical lags for monetary policy to affect the economy.

This isn't anyone's base case at the moment. True, the pace of job creation has slowed somewhat in recent months and the official unemployment rate moved up to 4.1% in June from 3.6% a year earlier. But, as Powell rightly noted on Wednesday, that is still low by historical standards. 

At his press conference, Powell repeatedly characterized the cooling of the labor market to this point as a process of normalization from its overheated state earlier rather than anything worrisome. But he also conceded that, "I would not like to see material further cooling in the labor market."

What should worry investors most is that the Fed hasn't left itself enough time to respond adequately should that material further cooling come about. This helps explain why futures markets imply some chance of a 50-basis point cut at one of the Fed's remaining meetings this year. If that happens, the Fed might regret not having fired the starting gun in July." [1]

"Leftists are desperate to have the Federal Reserve cut interest rates, believing that higher rates are hampering the “country’s ability to combat the climate crisis.”"

1. Why the Fed Risks Falling Behind --- Waiting until September to start cutting rates might have narrowed the Fed's room for maneuver. Back, Aaron.  Wall Street Journal, Eastern edition; New York, N.Y.. 02 Aug 2024: B.9.