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Thursday, February 6, 2025

Will a Week of Economic Rollercoaster Derail the Fed’s Rate Hike Plans?

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The Fed’s Tightrope Walk: Inflation Eases, But Will It Cut Rates?

The recent data deluge has presented a complex picture for the Federal Reserve, with inflation cooling down, the labor market holding steady, and the economy exhibiting resilience. This sets the stage for a crucial period for policymakers, starting with the upcoming Jackson Hole symposium. With inflation waning, the focus shifts towards the Fed’s next move: will they start lowering interest rates in September?

Key Takeaways:

  • Inflation is on the decline: Consumer prices have slowed to their weakest pace in over three years, while wholesale prices saw minimal growth in July.
  • The labor market remains sturdy: Layoffs are close to their long-term trend, and while wage growth outpaces inflation, it remains modest.
  • Easing concerns: The market expects the Fed to lower interest rates in September, with further cuts possible through the end of the year.
  • A crucial jobs report: The August nonfarm payrolls report, due in early September, will hold significant weight in the Fed’s decision.
  • The debate over cutting: Some economists argue that the Fed shouldn’t cut rates yet, citing persistent inflation and a strong economy.

Jackson Hole: The First Move

The Fed’s annual gathering in Jackson Hole, Wyoming, will be a key event this week. All eyes will be on Chair Jerome Powell’s speech on Friday, where he is expected to provide a roadmap for future monetary policy. While a definitive decision on rate cuts might not be announced, Powell is likely to signal the Fed’s stance towards easing.

"He still wants to give himself a little bit of room," said Quincy Krosby, chief global strategist at LPL Financial. "They don’t want to make a mistake on this side of the equation."

The Fed’s delicate balancing act involves deciding how swiftly and aggressively to respond to the cooling inflation. Recent data has shown signs of improvement, with:

  • Consumer price increases slowing significantly to their weakest pace in over three years.
  • Wholesale prices experiencing minimal growth in July.
  • Consumer spending proving more resilient than expected, suggesting people are weathering high interest rates.

However, challenges remain:

  • Housing remains a weak point, with construction starts and permits reaching a four-year low in July.
  • Wage growth, while outpacing inflation, is limited to 0.7%, highlighting continued pressure on real income.
  • Import prices are rising, with the annual pace hitting its highest level since December 2022.

Market Expectations and the Fed’s Dilemma

Despite the mixed signals, market sentiment suggests the Fed is poised to ease interest rates. The CME Group’s FedWatch tool points to a 3-to-1 chance of a quarter percentage point cut in September, with similar reductions expected in November and December.

However, worries persist about the Fed potentially lowering rates due to pressure for a "soft landing" rather than a genuine need for easing. A soft landing would involve gradually slowing the economy without triggering a recession.

"The market wants it to be commensurate with inflation coming down, not with an emergency rate cut," Krosby said. "The primal fear for the market is that we have a recession, and not a shallow recession but a deep recession that changes the equation completely."

August Payrolls Report: A Potential Game Changer

The August nonfarm payrolls report, scheduled for release in early September, will hold significant weight in the Fed’s decision-making. Former Fed Vice Chair Richard Clarida emphasized the importance of this report:

"Jay Powell says they don’t want to be data point dependent, and I think that makes sense. But I do think that there is special importance in what we hear about the labor market," he said. "If it’s a disastrous report, negative payrolls and a big rise in unemployment, then we’ll go 50. So I do think it’s data dependent for that first move."

The Case Against Cutting Rates

Not everyone believes the Fed should cut rates in September. Komal Sri-Kumar, head of Sri-Kumar Global Strategies, argues that the Fed should hold off, citing:

  • Persistent inflation: While overall inflation is easing, housing-related costs continue to rise, defying expectations of a downward trend.
  • Strong consumer spending: The 1% increase in retail spending in July suggests that consumers are holding strong despite high interest rates, potentially contributing to inflation.

"You [cut] because inflation is below target … The second reason you should be cutting is because the economy is weak," Sri-Kumar said. "Where is the weakness? I don’t think you have signs of weakness in the economy. You don’t have signs of inflation being controlled, and you don’t have any signal for the Fed to switch focus."

However, despite his reservations, Sri-Kumar anticipates that the Fed will cut rates regardless, and that Powell will signal this intention at Jackson Hole.

"He’s probably essentially going to give his indication, not only of that, but also pat himself on the back for success on inflation coming down significantly," he said. "So the big market rally does not have to wait until September 18. It has already begun, and he may give it one more piece of stimulus when he speaks in Jackson Hole."

Looking Ahead: A Tightrope to Balance

The next few weeks represent a crucial period for the Fed as it navigates a complex economic landscape. With inflation slowing but not entirely conquered, the potential for further interest rate cuts hangs in the balance. The upcoming Jackson Hole symposium and the August jobs report are likely to provide more clarity on the Fed’s future course. Ultimately, the Fed’s ability to engineer a "soft landing" for the economy will depend on its ability to make carefully calibrated decisions, while also avoiding the mistakes of the past.

Article Reference

Amanda Turner
Amanda Turner
Amanda Turner curates and reports on the day's top headlines, ensuring readers are always informed.

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