When Will The Fed Cut Rates, If Not Yet?

All eyes have been on the Federal Reserve to cut interest rates as they maintain the current rate for almost a year. The Nonfarm Payroll (NFP) readings for May 2024 show that the Fed is not inclined to cut rates soon. This raises a critical question: if not now, when then?

Why The Fed Will Not Cut Rates Soon
Recent economic data has presented a mixed picture, oscillating between signs of strength and weakness. The latest significant development was the report that nonfarm payrolls increased by 272,000 in May, surpassing expectations. This robust job growth makes the case for immediate Fed rate cuts less compelling.
Interest-rate futures now suggest that the Fed will not cut rates until September or November, according to CME's FedWatch Tool. This caution is reinforced by the slim 1.3% annualized growth in economic activity for the first quarter, coupled with a revised down consumer spending increase to 2% from the previously estimated 2.5%. Given that consumer spending constitutes over two-thirds of the GDP, this revision underscores the Fed's cautious stance.
Market sentiment began with expecting 7 rate cuts this year, driven by slower economic growth projections. However, with the latest data indicating stronger-than-expected job growth, predictions of rate cuts have become increasingly conservative, down to just 2.

What Will Happen If Fed Keeps Rates High
Maintaining high interest rates has several economic implications:

Economic Recession
High rates can lead to an economic slowdown or even a recession. Borrowing costs for consumers and businesses rise, reducing spending and investment. This, in turn, can slow economic growth significantly.

Reduced Stock Market Activity
High interest rates tend to dampen stock market enthusiasm. Investors often move funds away from equities into fixed-income securities that offer better returns due to higher interest rates. This shift can lead to lower stock prices and reduced market liquidity.

Consumer Impact
Consumers face higher costs for loans, including mortgages, auto loans, and credit cards. This can reduce disposable income and slow down consumer spending, further impacting economic growth.

Corporate Challenges
Businesses also face higher borrowing costs, which can lead to reduced capital expenditure and expansion plans. This can slow down business growth and innovation, leading to a broader economic slowdown.

What Needs to Happen for the Fed to Cut Rates
For the Fed to consider cutting rates, several conditions need to be met:

Sustained Decline in Inflation
The Fed's preferred inflation indicator, the personal consumption expenditures (PCE) price index, showed a 2.7% year-over-year increase in April, still above the central bank's 2% target. A consistent and clear downward trend in inflation is essential before any rate cuts are contemplated.

Economic Slowdown
A more pronounced slowdown in economic growth would push the Fed towards cutting rates. The current data shows mixed signals, and the Fed needs more definitive evidence of economic deceleration.

Labor Market Adjustments
The Fed aims to protect the strength of the labor market. Any signs of weakening in employment data could prompt the Fed to consider easing monetary policy to support job growth.

When Will The Fed Cut Rates
According to Goldman Sachs, the Fed is expected to cut rates twice this year, possibly in September and the fourth quarter. This prediction aligns with a forecast of slower GDP growth and a widening trade deficit. The upcoming Fed meetings in June and July will be crucial, with the July meeting expected to provide more guidance on potential rate cuts.
Morningstar Chief US Market Strategist David Sekera echoes this sentiment, suggesting that the Fed will start cutting rates in September. Sekera expects the Fed to signal this move during the July meeting, provided inflation continues to moderate and economic growth slows down as anticipated.

A Potential Scenario
If the Fed does not cut rates this year, it could have significant implications for the US stock market. According to Sekera, the market needs these rate cuts to move higher. Without cuts, the risk of a recession increases, which could lead to a downturn in the stock market and broader economic challenges.

Looking Ahead
The path to rate cuts is fraught with uncertainty. The Fed's decisions will be heavily influenced by upcoming economic data, particularly regarding inflation and job growth. Investors and market participants should brace for potential volatility as the Fed navigates these complex dynamics.
In summary, while the Fed is not poised to cut rates immediately, there are indications that rate cuts could occur later in the year, depending on economic developments. As always, vigilance and adaptability will be key for investors in these uncertain times.