Times, they are a changing…
- As Fed Chair Powell announced that “the time has come for policy to adjust” at his Jackson Hole speech last Friday. Of all of Powell’s recent public statements, this is the first time he has clearly and definitively communicated the central bank’s intention to start cutting the overnight Federal Funds rate. The question now is how much will the Fed cut and how frequently? The next Fed meeting is in three weeks, current forecast predicts a 70% chance of a 0.25 percentage point rate cut and a 30% chance of 0.50 percentage point rate cut. Before year-end, predictions are for a 76% likelihood of a 1 percentage point reduction in the overnight interest rate. In any scenario, we believe a larger initial rate cut would be unwarranted as it would likely spook the financial markets.
- When the Fed does begin cutting the overnight borrowing rate, it will have a significant impact across the fixed income markets. Rates that affect the average consumer such as credit card debt and home equity lines of credit should all be impacted. Most importantly, mortgage rates, which are largely priced upon the 10-Year US Treasury rate, should continue their recent drop as rate expectations have moderated over the last several weeks.
- This Friday the Fed’s preferred inflation gauge, the Personal Consumption Expenditures Price Index (PCE), for July will be released. The market is largely expecting this reading to continue its recent downward trend towards the Fed’s target goal of 2%. For the vast majority of this interest rate cycle, the PCE report has been the most watched report as the Fed placed increasing focus on reeling in inflation. At this point, the battle against inflation appears to largely be won. The Fed now is turning its attention to the labor market that has seen the unemployment rate recently increase to 4.3%, up markedly from last July’s 3.5% reading.
- Not helping the Fed newfound labor market attention was the Labor Department’s report last Wednesday which had surprising downward revision of 818,000 jobs created over the twelve months prior to March. Instead of adding on average 246,000 jobs a month, the U.S. economy added only 178,000 a month, or 28% fewer positions than had originally been believed. While economists had expected a downward revision, the revisions magnitude was unexpectedly large. Interestingly enough, the market took this news in stride and ended the day in the green.