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The Federal Reserve will hold the federal funds rate unchanged at 5.25%–5.50% at next week’s Federal Open Market Committee (FOMC) meeting, but we suspect policymakers will have a long and lively debate about whether and how to signal a September rate cut. In fact, some policymakers may even argue, as we have, that a July rate cut would have been optimal and preferable given current and expected economic conditions.
The policy statement will retain a myopic focus on recent data points, noting encouraging “moderate” inflation progress toward 2%, a rise in the unemployment rate, but robust 3.1 y/y GDP growth in Q2. The negative conditionality statement for rate cuts may be changed to a positive one (“the Committee expects it will be appropriate to reduce the target range once it has gained greater confidence …”) signaling openness to a September rate cut.
The Fed will continue tapering the quantitative tightening program with adjusted redemption caps on Treasury securities at $25b per month and on agency mortgage-backed securities at $35b.
There will not be an update to the Fed’s economic projections or the dot plot of median rate expectations, but if policymakers were once again surveyed, we believe the dot plot would feature two 25 basis points (bps) rate cuts in 2024, instead of only one as in June.
In his introductory remarks, Fed Chair Powell may introduce a reference to data having given policymakers “greater confidence” that inflation is sustainably moving toward 2%. He may also stress that inflation is no longer the only risk we face, and that considering a largely rebalanced labor market “reducing policy restraint too late or too little could unduly weaken economic activity and employment.”
During the press conference, however, Powell will likely want to retain as much optionality as possible. He will likely emphasize that every meeting is “live” and reiterate the now-familiar refrain stating that monetary policy remains dependent on the totality of data.
Even if he may have been open to easing policy in July, he will have no choice but to reiterate that more “good inflation readings” are needed to gain more confidence that inflation is sustainably moving toward 2%.
Still, a candid Powell is likely to note that personal consumption expenditures (PCE) inflation has fallen to 2.5% year over year (y/y) in June. He may (voluntarily or not) note that he anticipates the Committee will have greater confidence by September.
Softer consumer spending growth due to increased pricing sensitivity, reduced markups, moderating wage growth and declining rent inflation will continue to provide a healthy disinflationary impulse. We foresee the Fed’s favored inflation gauge, headline PCE inflation, ending the year around 2.4% y/y.
Most policymakers appear open to the idea of a September rate cut, and we suspect a few may have favored a July onset to the easing cycle given recent economic data. As Powell stated during his semiannual address to Congress, inflation is no longer the only risk the US economy faces. Maintaining excessively restrictive monetary policy when the labor market appears to be fully back in balance could lead to an undesired weakening of employment growth and the economy.
The views reflected in this article are the views of the author(s) and do not necessarily reflect the views of Ernst & Young LLP or other members of the global EY organization.
