Fed clears path for rate cut in September

Today's decision: As expected, the Fed left its key interest rates unchanged, leaving the target range for Fed Funds at 5.25% - 5.50%. The statement published after the meeting was adjusted: It takes note of the increased unemployment rate (previously it had always described an unchanged low unemployment rate) and sees some further progress towards the 2% inflation target. The risks to the Fed's objectives have come further into balance and the Fed is "attentive to the risks to both sides of its dual mandate" of full employment and price stability. This is a noticeable adjustment in communication, as previously the focus had only ever been on the risks to the inflation mandate. Today's decision was unanimous.

The press conference: The choice of words in the statement opens the door wider for a possible rate cut, but also leaves the Fed the option of waiting a little longer. However, Fed Chairman Jerome Powell was clearer in the press conference than the wording of the statement.

He now sees a higher quality of the disinflation process than in the second half of 2023, because back then it was mainly the prices of goods that had fallen significantly, whereas now there is also progress in services. Recent inflation data has given the Fed more confidence that it is on the right track. Powell also referred to the employment cost index published today, which turned out to be quite favorable from the Fed's perspective (Chart 1). In his view, the labor market is no longer a source of major inflationary pressure. Against this backdrop, Powell was satisfied with the cooling of the labor market, which he sees as a normalization. However, a further significant cooling of the labor market would not be welcome. The Fed is therefore keeping a close eye on the labor market.

Powell emphasized that risks for both parts of the Fed's mandate are now in better balance. The massive miss of the inflation target in recent years while the economy was at full employment had long required a primary focus on inflation. Powell indicated that the labor market is gradually moving to the top of the agenda. Thus, the employment report due to be published on Friday is gaining in importance.

Unsurprisingly, Powell refused to firmly announce a rate cut for the next meeting in September. However, if the inflation data and the economy develop as expected, a cut in September is on the table, he repeatedly said. However, this depends on the "totality of the data", not on one or two data points.

Powell admitted that a rate cut had already been discussed today (previously it had always been said that it was still too early for this). When asked whether a cut of 50 basis points would not be appropriate as a first step, given that they had waited so long to turn interest rates around, he replied that such a big move was not realistic.

Powell's statements confirm our expectation that the Fed will cut key interest rates by 25 basis points for the first time in September.

For full text see attached PDF-Version.