We Told You So…
Authors & Contributors
We warned you in March. Will history repeat itself?
Early this year, we warned that the market was getting ahead of itself by expecting the Federal Reserve (Fed) to cut rates in March. We notice a similar pattern emerging this quarter. After a couple cooler inflation prints this spring, a 25-basis point (bp) September rate cut is now 100% priced in fed funds futures. In our view, a September cut is not a done deal. Recent data has been encouraging, but the Fed is not out of the woods yet, with inflation still above the pre-pandemic norms that were consistent with price stability. We think the Fed will require more time and improvement in the data before having enough confidence that inflation is on a sustainable path to 2%. From our perspective, the chances of the Fed delaying its first ease until December are higher than markets currently appreciate.
The market has been upbeat after the last two subdued inflation prints, which showed consumer price inflation slowing to a 3% annual rate in June. Chair Powell noted that “in the second quarter, actually, we did make some progress” in taming inflation. Are a few data points enough to convince the Fed that inflation is on a sustainable path lower? The balance of risks looks inflationary given trade tensions and uncertainty around policy out of Washington D.C. in the medium-term. Policymakers may be overemphasizing the significance of the latest data while underemphasizing the possibility that the recent slowdown could be noise and a form of payback from the hot readings in the first quarter.
Services prices are still holding back progress on disinflation. In fact, inflation in the first half of 2024 was well above pre-pandemic norms and only a slight improvement over the second half of 2023. The labor market is cooling around the edges, but 4% average hourly earnings growth should continue to fuel service price increases. The Atlanta Fed sorts the components of the CPI into either flexible or sticky (slow to change) categories based on the frequency of their price adjustment. Sticky prices were 4.2% higher year-over-year in June, which were higher than levels associated with a swift return of overall inflation to 2%. Flexible prices, with their high energy and goods component, have cooled after turning higher in the first few months of the year. While a September ease has become the market consensus, it isn’t guaranteed.
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