Traders work on the floor of the New York Stock Exchange during morning trading on May 24, 2024 in New York City.
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Investors will likely have to bide out the summer as it looks increasingly unlikely that the Fed will cut interest rates.
A combination of stronger-than-expected economic data coupled with fresh comments from policymakers points away from any policy easing in the near term. Traders this week changed futures prices again, shying away from the possibility of a September interest rate cut and now anticipating just one by the end of the year.
The broader reaction was not kind, as stocks suffered their worst day of 2024 on Thursday and the Dow Jones Industrial Average broke what had been a five-week winning streak heading into the Memorial Day holiday.
“The economy may not calm down as much as the Fed would like,” said Quincy Crosby, chief global strategist at LPL Financial. “The market takes every piece of data and translates it into the way the Fed sees it. So if the Fed is data-dependent, the market will likely be more data-dependent.”
Over the past week or so, the data has sent a very clear message: economic growth is at least stable if not rising, while inflation is ever-present as consumers and policymakers alike remain wary of rising costs of living.
Examples include weekly unemployment claims, which a few weeks ago reached their highest level since late August 2023 but have since retreated to a trend that suggests companies have not ramped up the pace of layoffs. Then a less significant survey report came out on Thursday that showed stronger-than-expected expansion in both the services and manufacturing sectors, and purchasing managers also reported stronger inflation.
There is no reason to cut
Both data points came a day after minutes from the Federal Open Market Committee's latest meeting suggested central bankers still lack the confidence to cut rates and even an unspecified few say they might be open to raising interest rates if inflation worsens.
Furthermore, Fed Governor Christopher Waller said earlier in the week that he would need to see several months of data indicating that inflation is falling before agreeing to cut interest rates.
Taken together, there is little reason for the Fed to ease policy here.
“Minutes from the most recent FOMC meeting and the May FOMC meeting make clear that bullish inflation surprises this year, coupled with strong activity, are likely to rule out rate cuts,” Michael Gapen, an economist at Bank of America, said in a note. interest at the moment. “There also seems to be a strong consensus that the policy is in a constrained area, so increases are probably not necessary either.”
Some members at the most recent FOMC meeting, which concluded on May 1, asked whether “higher interest rates might have less impact than in the past,” the meeting minutes said.
Bank of America believes the Fed may wait until December to begin cutting, though Jabin pointed to a number of factors that could come into play regarding the mix between the potential for a labor market decline and easing inflation.
Incoming data
Economists like Gabin and others on Wall Street will be watching closely next Friday when the Commerce Department publishes its monthly outlook on personal income and spending that will also include the personal consumption expenditures price index, the measure of inflation that attracts the most focus from the Fed. .
The informal consensus expects a monthly gain of between 0.2% and 0.3%, but even this relatively muted gain may not give the Fed much confidence to cut rates. At this rate, annual inflation will likely remain at 3%, or remain well above the Fed's 2% target.
“If our forecasts are correct, the (year-on-year inflation) rate will fall by only a few basis points to 2.75%,” Jabin said. “There are very few signs of progress toward the Fed's target.”
The markets agree, albeit reluctantly.
While at the start of the year traders were anticipating at least six cuts, pricing on Friday afternoon moved to a roughly 60% probability that there would now be just one, according to CME Group's FedWatch tool. Goldman Sachs pulled its first expected cut to September, although the company still expects two this year.
The central bank's benchmark federal funds rate has ranged between 5.25% and 5.50% since last July.
“We continue to see interest rate cuts optional, which reduces the urgency,” Goldman Sachs economist David Merkel said in a note. “While the Fed leadership appears to share our relaxed view on inflation expectations and is likely to be ready to cut rates before too long, a number of FOMC participants remain more concerned about inflation and more reluctant to cut.”
