FOMC Review: Remaining Data Dependent

Summary

• Powell was more open to a September cut than I expected. However, he set out conditions I do not think can be met by September.
• Two 2024 cuts still appear unlikely as they would require significantly weaker employment or core PCE than set out in the SEP, which is not my base case.

Market Implications

• I still expect one 2024 cut in November or December, against market expectations of three cuts.

Fed Remains Data Dependent

Powell was more open to a September cut than I expected. However, I do not think the conditions he set will materialize by the September FOMC meeting. Therefore, I stick to my expectations of one 2024 cut.

As I expected, the Fed did not cut, and Powell did not commit to a September cut. Rather, he said the Fed was getting closer to cutting but the precise date of the first cut would depend on the data.

Today’s statement made official what Powell had been saying in recent public appearances, namely that the risks to the mandate’s inflation and employment legs are now balanced.

Powell repeated that the Fed needed more good inflation data before cutting. I think recent data justifies this (Chart 1). We have had only one month of shelter cost disinflation, and whether the past few months of very fast supercore disinflation will continue remains to be seen.

Conditions for Cut Unlikely to Be Met by September

With the risks to the mandate balanced, either inflation or employment could lead to a September cut.

I do not expect labour market weakness to trigger a September cut. I still expect a strong labour market, in line with growth that, as Powell stressed, remains well above trend.

Furthermore, as Powell has explained multiple times, a trigger would be labour market weakening rather than rebalancing. The ongoing increase in unemployment is not a trigger since it reflects rebalancing from a very low level rather than broad-based demand weaknesses. When asked about Sahm’s rule, Powell described it as an empirical regularity rather than a predictive rule; I agree.

I think inflation is a more likely trigger for a cut. Powell explained that a September cut would require ‘inflation moving down quickly or more or less in line with expectations’. Unfortunately, none of the reporters present asked Powell what those expectations were, but we can use the SEP to back out a range for core PCE prints. The SEP forecasts core PCE at 2.8% Q4/Q4, which implies average MoM prints of 20bp in H2, roughly the past three-month average.

However, as Powell repeated multiple times, the Fed does not respond mechanically to single data points but to the ‘totality of the data’ (the broad macro picture). In addition to low inflation prints, the Fed will be looking for quality prints: broad-based disinflation across goods, shelter and non-shelter services.

Finally, the Fed would need a broader macro backdrop consistent with disinflation, including continued wage growth slowdown and labour market rebalancing.

Powell’s inflation guidance is roughly consistent with that of Waller’s 17 July speech. Like Waller, I do not think inflation will have met these conditions by the September meeting – largely because I do not expect the recent pace of disinflation to continue – and that is why I stick to my expectations of a November cut. I also think that there are political advantages to cutting in November rather than September.

Two 2024 Cuts Unlikely

In the June dot plot, eight FOMC participants out of 19 had pencilled in two 2024 cuts, so the risk is significant. As Powell keeps reminding us, the SEP is the aggregation of individual forecast rather than a commitment to a consensus economic view. Nevertheless, the SEP is also a benchmark of sorts. I think a significant undershoot of employment or core PCE relative to the SEP would be required for a second 2024 cut, which is not my expectation.

Market Consequences

I still expect one 2024 insurance cut at the November or December FOMC meetings.

By contrast, following the FOMC, markets promptly priced bigger cuts, with the January 2025 FFR now at 4.40% from 4.46% on Tuesday. This ‘easing bias’ on the part of market participants suggests they may not be swayed much by forthcoming data and may not price out the September cut until told by the Fed, typically in a speech before the FOMC. That is, assuming that my view is correct.

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(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)