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 likely will have to sweat out a summer during which it looks increasingly improbable that the Federal Reserve will be cutting interest rates.
A batch of stronger-than-expected economic data coupled with fresh commentary from policymakers is pointing away from any near-term policy easing. Traders this week again shifted futures pricing, moving away from the likelihood of a reduction in rates in September and now anticipating just one cut by the end of the year.
The broader reaction was not pleasant, with stocks suffering their worst day of 2024 on Thursday and the Dow Jones Industrial Average breaking what had been a five-week winning streak ahead of the Memorial Day break.
“The economy may not be cooling off as much as the Fed would like,” said Quincy Krosby, chief global strategist at LPL Financial. “The market takes every bit of data and translates it to how the Fed sees it. So if the Fed is data dependent, the market is probably more data dependent.”
Over the past week or so, the data has sent a pretty clear message: Economic growth is at least stable if not on the rise, while inflation is ever-present as consumers and policymakers alike remain wary of the high cost of living.
Examples include weekly jobless claims, which a few weeks ago hit their highest level since late August 2023 but have since receded back to a trend that has indicated companies have not stepped up the pace of layoffs. Then there was a lower-profile survey release Thursday that showed stronger than expected expansion in both the services and manufacturing sectors and purchase managers reporting stronger inflation.
No reason to cut
Both data points came one day after the release of minutes from the last Federal Open Market Committee meeting indicating central bankers still lack the confidence to cut and even an unspecified few saying they could be open to hiking if inflation gets worse.
On top of that, Fed Governor Christopher Waller earlier in the week said he would need to see several months’ worth of data indicating that inflation is easing before agreeing to lower rates.
Put it together, and there’s not much reason for the Fed to be easing policy here.
“Recent Fedspeak and the May FOMC minutes make it clear that the upside inflation surprises this year, coupled with solid activity, are likely to take rate cuts off the table for now,” Bank of America economist Michael Gapen said in a note. “There also seems to be strong consensus that policy is in restrictive territory, and so hikes are probably not necessary either.”
Some members at the most recent FOMC meeting, which concluded May 1, even wondered whether “high interest rates may be having smaller effects than in the past,” the minutes stated.
BofA thinks the Fed could wait until December to start cutting, though Gapen noted a number of wildcards that could come into play regarding the mix between a potentially softening labor market and easing inflation.
Incoming data
Economists such as Gapen and others on Wall Street will be looking closely next Friday when the Commerce Department releases its monthly look at personal income and spending that also will include the personal consumption expenditures price index, the inflation gauge that draws the most focus from the Fed.
The informal consensus is for a monthly gain between 0.2% and 0.3%, but even that relatively muted gain might not give the Fed much confidence to cut. At that rate, annual inflation likely would be stuck just shy of 3%, or still well above the Fed’s 2% goal.
“If our forecast is correct, the [year-over-year inflation] rate will drop by only a few basis points to 2.75%,” Gapen said. “There is very little sign of progress towards the Fed’s target.”
Markets agree, if reluctantly.
Where traders at the beginning of the year had been anticipating at least six cuts, pricing Friday afternoon moved to a roughly 60% likelihood that there now will be only one, according to the CME Group’s FedWatch Tool. Goldman Sachs pulled back its first expected cut to September, though the firm still expects two this year.
The central bank’s benchmark fed funds rate has stood at 5.25% to 5.50% since last July.
“We continue to see rate cuts as optional, which lessens the urgency,” Goldman economist David Mericle said in a note. “While the Fed leadership appears to share our relaxed view on the inflation outlook and will likely be ready to cut before too long, a number of FOMC participants still appear to be more concerned about inflation and more reluctant to cut.”
