The latest signs of cooling inflation suggest that the Federal Reserve may gain enough confidence to cut interest rates this fall.
After the release of favorable Consumer Price Index (CPI) numbers on Thursday, the odds of a rate cut in September jumped, with traders now pricing in an 83% probability of an easing at the Fed’s meeting on Sept. 17-18.
“I think it puts September firmly on pace for a cut,” said a macro strategy expert
Some analysts believe that a rate cut at the Fed’s July 30-31 meeting is now a possibility, contingent on additional economic data. “The Fed could very well lower rates sooner than September if the labor market softens at a faster clip,” said a chief global strategist for a financial services firm.
The CPI on a “core” basis, which excludes volatile food and energy prices, rose 3.3% year-over-year in June, slightly below expectations and the level seen in May. Month-over-month core CPI also showed promise, rising 0.1% after a 0.2% increase in May.
The modest month-over-month increase “strengthens the case for a September rate cut,” according to a chief economist. However, much depends on upcoming readings of the Fed’s preferred inflation gauge, the “core” Personal Consumption Expenditures index (PCE), and further cooling of the jobs market.
San Francisco Fed President, speaking with reporters after the CPI release, said the timing for rate cuts is “closer than six months ago,” but more data is needed before making a decision. “With the information we have received today, including data on employment, inflation, GDP growth, and the outlook for the economy, I see it as likely that some policy adjustments will be warranted,” she said.
Another Fed President also expressed cautious optimism, stating that the new CPI numbers “point to encouraging further progress towards lower inflation” but emphasized the need for more evidence that inflation will converge to 2%.
A macro analyst said June marks the third consecutive month of moderate inflation growth, confirming a downward trajectory. However, achieving the Fed’s 2% inflation goal might not be smooth due to tougher annual rate comparisons in the latter half of the year.
“For the Fed to justify rate cuts, it will need to focus on a decelerating labor market rather than relying solely on inflation softening,” the analyst said. “Today’s report and the Fed’s subtle shift to a balanced focus on employment growth help set the stage for a September rate cut.”
Fed Chair Jay Powell highlighted the importance of a cooling labor market, noting recent data indicating significantly less overheated conditions compared to two years ago. “This is no longer an overheated economy,” Powell told lawmakers.
The Fed has maintained high rates to curb inflation, but with the job market normalizing, it is now considering both price stability and maximum employment in its policy decisions.
The San Francisco Fed President echoed this sentiment, saying more attention is now on the labor market. “I’m looking at the labor market, which is coming into better balance, and additional slowing is likely to result in a rise in unemployment,” she said.
The focus on the job market follows last week’s unemployment report showing a gently cooling labor market, with the rate ticking up to 4.1% for the second consecutive month. While still historically low, this is an increase from 3.4% early last year.
Powell expressed optimism about potential rate cuts, citing evidence of cooling inflation and encouraging data. “The inflation numbers have shown modest progress, and more good data would strengthen our confidence that inflation is moving sustainably toward 2%,” he said. However, Powell did not commit to a September cut, cautioning that more evidence is needed to ensure inflation is on track to meet the 2% target.