In a widely anticipated move, the Federal Open Market Committee (FOMC) made no changes to policy rates or balance sheet runoff at today's meeting. However, modest but important changes to the post-meeting statement and a press conference that focused on a shift in the ''balance of risks'' leave September wide open for a rate cut.
In the prepared statement, the committee appropriately adjusted its descriptions of both the labor market and inflation to reflect recent data trends. Job gains, previously described as ''strong,'' were now said to have ''moderated,'' and the unemployment rate ''moved up but remains low.'' On the inflation front, recent benign readings allowed the committee to acknowledge that ''some'' further progress toward the 2.00% objective had been made. And perhaps most notably, longstanding language describing the committee as being ''highly attentive to inflation risks'' was replaced entirely by language that describes a committee that is now ''attentive to the risks to both sides of its dual mandate.''
At the press conference, Federal Reserve (Fed) Chair Jerome Powell used his prepared remarks to highlight what he characterized as solid economic activity, ongoing progress on inflation and a labor market that continues to move back into better balance. In the Q&A portion, most of the discussion revolved around the criteria used to assess the appropriateness and timing of future rate cuts. As he's done in the past, Powell was quick to assert that decisions are made on a meeting-by-meeting basis based on multiple data points and that any policy rate adjustments would carefully consider the totality of the ''incoming data, the evolving outlook, and the balance of risks.'' As expected, Powell stopped short of fully committing to a rate cut in September, but there were many times during the press conference when he alluded to that being a reasonable base case. Giving more credence to the idea of a September cut was Powell's admission that the committee discussed the possibility of a July cut before ultimately deciding against it. When asked about the possibility of a 50-basis-point (bp) cut to kick off the cycle, Powell seemed to downplay that as a possibility.
Regarding the ''balance of risks,'' it's clear from today's communication that the committee views upside risks to inflation as having receded and downside risks to the labor market as having increased. At Western Asset, we are in full agreement with this characterization. While it's too early to definitively say whether recent labor market trends fall under the category of ''normalization'' or something more sinister, a rising unemployment rate, moderating wages (as seen in today's Employment Cost Index), declining job openings and softer hiring rates likely mean that the current state of the labor market is not putting upward pressure on inflation. Treasuries rallied after Powell's press conference. Interest-rate swaps showed traders have fully priced in more than a full 25-bp cut in September, and a total of more than 70 bps worth of reductions by the end of the year.
With recent Consumer Price Index (CPI) data coming in exceptionally low due to the lagged effects of shelter inflation finally showing up in the official measures, we would not be surprised to see two additional benign inflation prints prior to the September FOMC meeting. In our view, these prints combined with downside risks in the labor market will be enough justification for the Fed to begin a rate-cutting cycle in September. In our base case, we look for the FOMC to cut rates at every other meeting beginning in September. Risks are skewed toward more and faster cuts as any combination of a more precipitous decline in inflation, accelerating labor market weakness or an unexpected growth slowdown would likely cause the FOMC to return policy rates to a more neutral posture in short order.