Instant Insights: CPI back in the right direction | Insight Investment

As markets expected, the Fed held the federal funds rate at 5.25%-5.50%. Chair Powell appeared to begin setting the stage for a potential rate cut in September.

The Fed is getting closer to achieving its dual mandate

The Federal Open Market Committee (FOMC) made some notable amendments to language in its latest official statement, acknowledging signs of loosening in the labor market and softening inflation. Chair Powell noted “considerable progress” toward its dual mandate.

The FOMC changed its characterization of job gains from “strong” to having “moderated”. It also noted the unemployment rate is now “moving up” while remaining “low”.

We suspect a concern of some officials may be the unemployment rate closing in on triggering the so-called “Sahm rule”. The indicator is measured by the current 3-month average unemployment rate, minus its minimum value over the previous 12 months. Every time the indicator has breached 0.5%, it has coincided with a recession. Currently, its value is 0.43% (Figure 1). Powell stated he “would not like to see further material cooling in the labor market”, albeit “the chances of a hard landing are low”.

Figure 1: The unemployment rate may worry some FOMC members

Regarding inflation, the FOMC removed a phrase stating it is “highly attentive to inflation”, instead noting a softer stance of being “attentive to risks to both sides of its dual mandate”.

Chair Powell also noted that inflation had eased “considerably”, although the committee remained cautious about declaring victory. It retained language about requiring “greater confidence that inflation is moving sustainably toward 2%”, albeit Powell stated that recent inflation prints have “added to our confidence, and more good data would further strengthen that confidence”.

This reflects how the Fed’s favored inflation metrics have made notable progress. For example, headline PCE inflation is below the Fed’s 2% target on a 3-month annualized basis, with core PCE close to target at 2.3% (Figure 2).

Figure 2: The Fed’s preferred inflation measures are close to its 2% target

The Fed may join global rate-cutting cycle soon

Although US investors have had to wait for rate cuts, the international rate-cutting cycle has been under way for some time. Several emerging markets began cutting rates in 2023, and developed markets followed earlier this year (Figure 3). We believe it may only be a matter of time before the Fed joins in.

Figure 3: The global rate-cutting cycle has begun, it may only be a matter of time before the US joins

We expect to see the first rate cut in september

Chair Powell emphasized that “no decisions” have been made about the September meeting, albeit “a rate cut could be on the table” and “the economy is moving closer to the point where it will be appropriate to reduce our policy rate”.

If data continues to improve, we suspect that Chair Powell will use his address at next month’s Jackson Hole Symposium to offer further indications about potential rate cuts. We see a cut in September as the most sensible base case.

Until then, we continue to believe it may be a good time for investors to consider adding fixed income exposure while rates remain at the top of the cycle.