US reaction: FOMC unch, but signals September

The FOMC left monetary policy unchanged at its meeting in July, the Fed Funds Rate target remained at 5.25-5.50%, the interest rate on excess reserves at 5.40% and the pace of QT unchanged at $25bn per month for US Treasury maturities and $35bn for agency debt and mortgage backed securities. This by unanimous decision and was in line with market expectations.

Yet if policy were unchanged, the accompanying statement saw a number of changes, if nuanced overall. Jobs growth was described now as moderate (from “remained strong”), while the unemployment rate overall was acknowledged to have “moved up, but remains low” (from “remained low”). Inflation was in turn characterized as “somewhat” elevated (from “elevated”) and the Committee considered this “some” further progress (from “modest”). Finally, the Committee described the risks to its goals as “continue to move into better balance” (from “have moved”). The Committee left its guidance unchanged that it required “greater confidence that inflation is moving sustainably toward 2%” before it would be appropriate to ease policy. However, it replaced the long-standing skew to its risks from being “highly attentive to inflation risks” to being “attentive to the risks to both sides of its dual mandate”. The statement thus signaled a material shift in the Fed’s communication.

Fed Chair Powell went on to emphasize this shift in his press conference. In his opening remarks Powell read that the Committee was squarely focused on its dual mandate; that the economy was strong but not overheated; and that Q2 had added to the Fed’s confidence that inflation was moving back to target and more good data would further strengthen that confidence. But across the course of the press conference, while Powell at times repeated the contingent nature and the real need to assess the incoming data, the presumption seemed very clear that the Fed would move with Powell at the end summarizing the Committee’s discussion as suggesting that a cut was necessary “not at this meeting, but as soon as the next meeting … assuming that the totality of the data supports such an outcome”. We think that this expressed the direction of policy clearly enough. However, Powell did push back against the tone of further questioning suggesting that the Fed was easing policy too slowly and that recession risks had grown. He repeatedly referred to the solid pace of private domestic final demand of 2.6% in H1 2024, which he described as solid and explicitly characterized his view of the risks of a hard landing as “low” suggesting that that was not what the data showed.

We continue to expect the Fed to ease policy at the next meeting in September. However against a backdrop that sees some loosening in the labour market, but still largely attributed to the improvement in supply conditions, rather than a weakening in the employment outlook, and conditions generally in place for an easing in inflation over the next year, we expect this move to be a gradual easing of policy restrictiveness. We do not consider it to be the start of a significant reversal of previous policy to offset a marked drop in economic activity. As such, we expect the Fed to ease by 0.25% in September – not the 50bps that markets started considering earlier this month – indeed Powell dismissed this explicitly, saying “that is not something we are thinking about right now”. We then expect a further easing, but only in December, different from some calls for a November cut and market’s pricing a greater than 50% chance of three cuts this year. Next year remains less certain and we consider likely dependent on November’s election outcome. We currently consider the likelihood of the re-election of President Trump. Based on his economic agenda, we expect the Fed to cut rates at most only twice next year (March and September) – and perhaps not even that if Trump delivers on all of his economic programme.

Financial markets certainly acknowledged the Fed’s signaled direction. Markets had fully-priced a September cut before the meeting and now consider a little over a 5% chance of more than that; pricing for December rose from a 60% chance of three cuts this year to a 75%. As such 2-year US Treasury yields dropped 8bps to 4.28%, 10-year yields fell 4bps to 4.07% and the dollar fell by 0.2% against a basket of currencies.