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While acknowledging further progress on economic data, the July Federal Open Market Committee (FOMC) statement gave little indication on the timing of the first rate cut. During his post-meeting press conference, Fed Chair Jerome Powell provided some fodder for the doves hoping for explicit guidance that cuts (consistent with current market pricing) would commence in September, noting that conditions could be in place to warrant a cut “as soon as the next meeting.” Though the Fed maintains an easing bias, the Committee appears content to wait for more inflation and labor data to boost its confidence in its benign outlook before cutting policy rates.
The Fed hinted that it may be placing more emphasis on the recent weakness in the labor market by replacing its language in the statement that it “remains highly attentive to inflation risks” to reinforce that it “is attentive to the risks to both sides of its dual mandate.” The labor market has shown some signs of softening in recent months as wage pressures have moderated and the unemployment rate has ticked above the Fed’s forecast for the end of this year. This has been fueled in part by an immigration-driven increase in labor force participation. However, the Fed’s preferred inflation gauge — core personal consumption expenditures (PCE) — stalled at 2.6% year over year in June. While some base effects (low comparisons from last year) will likely put upward pressure on inflation in the coming months, I think this will be offset by further weakening in the shelter component, the decline of which accelerated last month.
The Fed may feel some pressure to kick-start its easing campaign sooner given that it lags many of its developed market peers. The European Central Bank, Swiss National Bank, and Bank of Canada have all cut policy rates this year, with the Bank of England expected to follow suit on August 1. If it keeps interest-rate differentials wide for too long, the Fed risks persistent US-dollar strength that makes US exports unattractive, hurting growth prospects. Though currency dynamics are not part of the Fed’s mandate, it remains attuned to these risks, as well as the adverse impact on financial conditions of keeping policy rates higher for longer.
Powell reiterated during his press conference that monetary policy remains independent of political developments, but inflation outcomes are likely to be quite different, depending on who wins the US presidential election. A Harris victory would likely ensure a great deal of policy continuity carries over from the Biden administration. On the other hand, inflation is likely to be significantly higher under Trump due to the accompanying impacts of his proposed trade and immigration policies. In the run up to November’s election, I expect to see additional volatility in markets as investors calibrate asset values based on the potential impacts of trade, tariffs, taxes, and regulatory changes as the polls oscillate.
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