The outlook for the Federal Reserve (Fed) through the first six months of 2024 has been a bit of a roller-coaster ride to say the least. While one could argue the overarching premise has been for rate cuts, it has certainly not been a smooth ride. So now as we enter the second half of the year, investors are beginning to wonder if some clarity is beginning to come into view.
First, let’s get back to the fluctuating market expectations. The money and bond markets began this year discounting a total of six rate cuts worth 150 basis points (bps) in total. In addition, the first easing move was expected to begin at the March Federal Open Market Committee (FOMC) meeting. We all know how that has turned out. Fast-forward to July, and the expectation is for a potential September starting point with perhaps two rate cuts worth 50 bps in total. Interestingly, before the markets arrived at their current projections, there was actually a time in late April when another rate hike even entered into the discussion.
For the record, at the June FOMC meeting, the Fed’s dot plot downgraded the expected number of rate cuts for this year from three to only one. However, with last month’s inflation reports revealing a trend back toward disinflation, the “dots” have become obsolete in the eyes of the bond market, with two easing moves being the predominant mindset currently.
That brings us to a discussion that is beginning to take on more credence of late: the Fed may not wait until their 2% inflation goal is achieved before making a move to reduce the Fed Funds target. As a reminder, this thought is not necessarily breaking new ground. Chairman Powell hinted earlier this year that perhaps inflation doesn’t need to get down precisely to their 2% goal. Looking at the Fed’s preferred measure, the core Personal Consumption Expenditure (PCE) Deflator, the latest reading came in at +2.6%, a level that is getting closer to the policy makers’ target.
While there is an FOMC meeting at the end of July, perhaps a more important event will be Powell’s annual appearance at the Fed Kansas City’s Jackson Hole symposium on August 22–24. By this time, the voting members will have received two more Consumer Price Index (CPI) reports, an additional PCE Deflator reading and one more jobs number. With Powell highlighting how monetary policy is so data dependent, if the data come in “just right,” one could argue the Chairman could use this venue to potentially provide forward guidance for a rate cut at the September convocation.
The natural question to ask is: where will the core PCE Deflator be at that point? Let’s assume disinflation remains intact. That could mean the year-over-year reading may be at +2.5% by the time of the Jackson Hole appearance. Is this level of inflation then viewed as the new 2% Fed target? For the record, the Fed does get another PCE Deflator reading prior to the September FOMC meeting. While a number below the aforementioned +2.5% is possible, odds would favor the reading would still not have fallen to 2%.
That is the conundrum Powell & Co. could be facing later this summer. And don’t forget the labor market data, as this part of the Fed’s dual mandate could wind up being a key arbiter in the policy makers’ decision-making process.
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