Will the FED cut rates in September?

>> FED and ECB’s monetary policy has shifted a lot

Are they likely to be confident now that inflation reports have improved so much and the unemployment rate has continued to climb? Many people think so. That should put the first rate cut in the cycle in play for the September 18^th meeting. The question now is whether Fed members feel sufficiently confident to signal at the July 31^st meeting that September is a ‘live’ meeting.

The US's June CPI report revealed a totally unexpected fall in headline monthly prices while the 0.1% rise in core prices was also below the consensus. What was notable was the weakness in so-called ‘supercore’ CPI prices. This measure looks at core services prices and strips out housing. It was flat in the month to follow a similarly flat figure in May. That’s very different to the 0.6% average that we saw in the first four months of this year and even the 0.3% average seen during the whole of 2023.

Admittedly, the Fed’s supercore focus relates to its targeted inflation measure of PCE prices, not the CPI, and the two are not the same. Nonetheless, supercore CPI data is a reasonable guide to the PCE equivalent and, by the time of the July 31^st meeting the Fed will have seen the supercore PCE measure as well.

Why is this supercore measure of importance for the Fed? It is significant because it largely reflects the impact of wage pressures on prices. In addition, food and energy prices are excluded because they are volatile, and housing is excluded because this is a lagging indicator of what’s happening in the rental market. In addition, a key part of the housing component is owners equivalent rent (OER) which is designed to measure the opportunity cost owing to households for not renting out their home. If this sounds silly, that’s probably because it is. The OER is not a true price that anybody pays, so excluding it seems to us to be a good idea in any case.

In sum, the collapse in supercore prices not only suggests that wage-related pressure is easing; it might be a broader sign of growing weakness in the labour market and probably a further signal that firms are losing pricing power, which we are already seeing in many earnings reports.

>> FED is still minded to ease

Armed with this information, and more, will the Fed cut rates in September? Steve Barrow, Head of Standard Bank G10 Strategy thinks so. Will it be sufficiently confident about a September cut that it can signal a future reduction is coming at the July meeting, or perhaps some time between the July and September meetings? History suggests that the Fed likes to give this sort of clear guidance. We don’t exactly know why.

Steve Barrow assumes that it is because it does not want changes in the direction of rates to come as a shock to the market and so provoke an adverse reaction. But while there might be advantages to letting the market know in advance, there might also be costs if the Fed ‘promises’ a rate cut that it can’t deliver. It might also run into the problem the ECB faced recently where it ‘promised’ a rate cut, but intervening data questioned the wisdom of such a reduction. In the end, the Bank did lower rates in June but the quid pro quo with the bond market vigilantes seems to have been a ‘promise’ not to have a follow-up cut at the July meeting.

In Steve Barrow’s view, the Fed should heed this and, if members really do want to signal a future rate cut they should do so only in the period just ahead of the September meeting, although this can be a bit awkward as FOMC members are subject to a blackout period from September 7^th that prevents them talking about monetary policy.

Nonetheless, a strong hint of a future cut is very possible at the July 31^st FOMC meeting and that could make things particularly interesting for the US dollar against the yen as the BoJ meets the same day and seems likely to outline its plan for smaller JGB purchases, if not another hike in the short-term policy rate. In addition, it could try to ram home any advantage with FX intervention. In short, US dollar/yen looks to be the play for those looking for the Fed to hint at a September rate cut at the July meeting.