Fed Rate Cut Hopes Rise Amid Mixed Economic Signals: Markets React Positively

Markets, including crypto, briefly rose after Thursday’s Consumer Price Index (CPI) report showed that prices cooled more than expected in June, raising hopes among traders that the Federal Reserve might cut interest rates this year, according to CoinDesk. Despite Friday’s Producer Price Index (PPI) data coming in hotter than expected, traders remained optimistic that the central bank will cut the Fed rate in September, with the odds at 93.8%., according to CME’s Fed Watch tool.

The Federal Reserve has a dual mandate: to maintain stable prices and promote maximum employment. A weakening labor market could compel the Fed to ease monetary policy before inflation reaches its 2% target (June’s CPI data indicated a 3% year-over-year inflation rate). The U.S. unemployment rate has increased for three consecutive months, reaching 4.1% in June from 3.8% in March.

John Leer, head of economic intelligence at Morning Consult, remarked, “I do believe the labor market is going to be the bigger risk to the economy going forward. While it shows signs of cooling, it remains very strong by historical standards. It would be a historical anomaly if the Fed manages to successfully engineer a soft landing, i.e., tame inflation without triggering a recession.”

Federal Reserve Chair Jerome Powell stated at a congressional hearing on Tuesday, “The labor market appears to be fully back in balance.” He also told the Senate panel that the job market was no longer “a source of broad inflationary pressures for the economy.”

Olu Sonola from Fitch Ratings commented, “The Fed will be worried that the negative trend may be a turning point for additional weakness in the labor market down the road.”

Powell noted that the risk balance between the unemployment rate and inflation is now two-sided, with the labor market back in balance. This could prompt the Fed to start cutting rates sooner, as inflation appears to be moving towards the 2% target. He highlighted data showing “modest further progress” and emphasized that more positive data would strengthen their confidence that inflation is moving sustainably towards the target.

Powell added that while labor market conditions have cooled, they remain strong. However, lowering Fed rates too early could jeopardize the plan to control inflation, whereas maintaining high rates for too long could unnecessarily increase unemployment. He acknowledged that “elevated inflation is not the only risk we face,” expressing concerns that prolonged high borrowing costs could “unduly” harm the economy.

Powell stated that policy decisions would be made on a “meeting by meeting” basis, hinting that the Fed’s next move might be to cut the Fed rate, not increase them. However, Markus Thielen of 10x Research warned that even if the Fed starts to cut rates, it might not be as bullish of a signal as some traders think. In a weakening economy, investors might pull money out of risk assets, including crypto, to allocate it to safer investments.

As the U.S. approaches elections, the Fed’s decisions may be swayed by political pressures, with economic conditions scrutinized for their dual implications on policy and electoral dynamics. Economic indicators such as inflation rates, job creation numbers, and interest rate policies take on heightened significance during election cycles, as they directly influence public perception of the incumbent’s economic stewardship.

The Fed’s delicate balancing act between stimulating economic growth and curbing inflation could be influenced by electoral dynamics, where policies that stimulate economic activity and lower unemployment rates might be prioritized to bolster the sitting administration’s electoral prospects. Conversely, overly aggressive monetary policies that risk economic instability could be avoided to prevent negative voter sentiment. This intersection of economic policy and electoral strategy underscores the nuanced role of the Federal Reserve in navigating both economic imperatives and political realities as the election approaches.