Last week’s deluge of data left some clear impressions: inflation is trending upwards, the labor market looks OK if not on fire anymore, and the economy isn’t headed for a cliff fall, even though a major slowdown is always a possibility. This is the backdrop for a crucial period ahead for Federal Reserve policymakers. Next week begins with the central bank’s annual meeting in Jackson Hole, Wyoming, followed by a make-or-break employment report in the first week of September, followed by more important economic data, and concludes with the Fed’s policy meeting on September 17-18. First, Chairman Jerome Powell’s policy speech next Friday, concluding the Jackson Hole meeting, is expected to at least outline (with pencil, not pen) what the outlook is. There’s also enough flexibility to ensure the Fed isn’t fooled again, as it was in the early days of the inflation spike. “He still seems to want to give them some leeway. Let’s not forget that the Fed made a mistake in viewing inflation as temporary,” said Quincy Krosby, chief global strategist at LPL Financial. “That mistake will go down in history. The Fed delayed doing what they should have done. They don’t want to make a mistake on this side of the equation.” Specifically, the Fed faces the question of how quickly and aggressively to respond now that inflation is weakening. Here’s what the latest rapid data tells us: Consumer price inflation slowed to its lowest level in more than three years, wholesale prices barely rose in July, spending is much stronger than expected, and layoffs are moving closer to their long-term trend after a brief surge a few weeks ago. Of course, it’s not all good news. Housing remains a weak spot in the economy, and it seems to be getting worse, judging by construction starts and permits hitting their lowest levels in four years in July. Wages are rising, but only 0.7% faster than inflation. Looking at inflation, it’s showing up in imports, where the annual pace of price increases is just 1.6%, but it’s reached its highest level since December 2022. Preparing for Easing Still, overall, the market feels that for the most part, the Fed can and should start cutting interest rates next month. “It’s not an exact science. It’s probably as much art as it is science,” Crosby said. “The longer they wait, the more problems they’ll have. The problems will be different, but they’re going to have problems.” Friday afternoon market prices suggested about 3-to-1 odds of a 0.25 percentage point (25 basis point) cut in September, according to FedWatch, an index of CME Group’s federal funds rate futures contract. From there, traders are banking on similar moves in November and December, with a final cut this year of perhaps 0.5 percentage points. The biggest concern now is that the Fed is cutting rates because it wants to steer the economy toward its vaunted soft landing, not because it has to force the economy to move dramatically in the event of a labor market crash or other crisis. “The market wants a cut that’s commensurate with the fall in inflation, not an emergency cut,” Crosby said. “The first thing the market is afraid of is a recession. And not a shallow recession, but a deep recession that completely changes the equation.” Former Fed vice chair Richard Clarida, who described himself as a “founding member of the temporary team” during his tenure, said he thinks the most likely path now is a quarter-point cut in September. But Clarida also predicted that the August nonfarm payrolls report, due in early September, will have a big impact, even though Powell stressed that the Fed is “data-dependent” and not “data-point-dependent.” “Jay Powell has said he doesn’t want to rely on data points, and I think that’s reasonable. But I want to emphasize that I think there’s special importance to what we hear about the labor market,” Clarida said in an interview with CNBC on Friday. “If we get a dire report, meaning negative payrolls and a big increase in employment, we’ll raise it to 50%. So I think the first move will depend on the data.” Reasons for no cuts To be sure, not all market participants are in favor of a rate cut. Despite the increased emphasis on the employment situation, Powell and other Fed officials are unlikely to declare a complete victory over inflation, and there are good reasons for that, said Komal Sri Kumar, head of Sri Kumar Global Strategies. While overall inflation numbers are falling, housing-related costs are continuing to trend downward, bucking expectations, and a solid 1% increase in retail spending in July suggests consumers are tolerating high interest rates, which is itself an inflationary trend. [cut] “The second reason to cut rates is because inflation is below target…the economy is weak,” Sri Kumar said. “Where is the weakness? I don’t think there are any signs that the economy is weakening. There are no signs that inflation is subdued, and there are no signals that the Fed is going to change its focus.” But Sri Kumar expects the Fed to cut rates anyway, and that Powell will send a strong signal at Jackson Hole that easing is on the way. “He’ll probably be patting himself on the back that not only is that a sign, but that inflation is coming down substantially,” he said. “So the big market rally doesn’t have to wait until Sept. 18. It’s already started, and he could be on the verge of more stimulus when he speaks at Jackson Hole.”
How the week’s biggest economic news stories will affect Fed decision-making
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