How Likely Is It That The Fed Will Cut Rates?

The U.S. Consumer Price Index declined 0.1% in June compared to the previous month, marking the first monthly decline in four years. This surprising decline in the general price level in the country is a testament to how the Fed has successfully curbed inflationary pressures through restrictive monetary policy decisions such as interest rate hikes. For the 12 months ended June 30, the CPI increased just 3%, which is the smallest gain reported since June 2023. This is another sign that inflation is continuing to trend lower, paving the way for future rate cuts. Stocks are reacting positively to this development with the S&P 500 index up almost 60 basis points in the first hour of trading today.

From 3 to 1... Maybe

Fed officials were expecting three rate cuts for 2024 at the beginning of the year but today, FOMC members are pointing toward a single rate cut this year. The slower-than-expected deceleration of inflation and the surprising resilience of the economy have played key roles in proving Fed officials wrong this year. Even today, core inflation is moderating at a slow pace, which has eliminated the need for aggressive rate cuts this year. Going by the recent remarks of Fed Chair Jerome Powell, policymakers are wary of aggressive rate cuts creating asset bubbles which would eventually burst and push the economy into a recession. To avoid such a catastrophic outcome, the Fed plans to cut rates only when there is proof of a sustainable decline in inflationary pressures. With inflation still persistently higher than the Fed’s long-term target of 2%, there does not seem to be an urgent need to stimulate the economy by cutting rates too soon.

Weighing The Odds

Before yesterday’s CPI report, the market was implying a 70% probability of a rate cut in September. Since the report, the odds of a September rate cut have jumped to around 85%, highlighting the growing optimism among investors for the first rate cut to be announced in the Fed’s next meeting. William Blair analyst Richard de Chazal, after digesting the June CPI print, claimed that the probability of a rate cut in September has increased dramatically this week due to cooler-than-expected inflation and the Fed’s more encouraging language.

With the Presidential election looming on the horizon, a Fed rate cut is likely to help President Joe Biden’s campaign as it would boost consumer confidence in the American economy. The White House was quick to point this out after yesterday’s inflation report. In an official statement, the White House claimed that June inflation numbers revealed the progress the Biden administration has made toward repairing the economy since the pandemic. Inflation has been a battleground topic between Biden and Trump in the last few weeks, and favorable data on this front is likely to tilt the odds in favor of Biden although his re-election campaign has faced major hurdles since the Presidential debate a few weeks ago.