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September 13, 2024

News in Charts: Fed watch

by Fathom Consulting.

The FOMC meets next week, faced with an economy facing downside risks to the labour market but still-firm inflation. That they will cut interest rates is not really in question. The Chair widely flagged such a move last month, noting that “the time has come for policy to adjust”. However, he noted that the “timing and pace of cuts” will depend on an “evolving outlook” and the “balance of risks”. While there have been clear signs of labour market softness, this week’s inflation reading was a reminder that upward price pressures persist.

The fed funds rate in 2025, which is implied by market pricing, has steadily declined over the summer. This figure dropped from an anticipated 4.34% at the end of May to as low as 2.78% in September, with only a small uptick following the inflation data. The mean Fathom view is that this figure will be somewhat north of 4%, although there is a large degree of uncertainty around this projection.

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The Federal Reserve has a dual mandate: 1) maximum employment and 2) price stability, which they define as 2% headline inflation on the PCE measure. Much of the repricing in interest rates reflects signs of weakness in the former. The unemployment rate has been drifting up, while vacancies have dropped and jobs gains have slowed, with the six-month average in monthly jobs gains dropping from 236,000 in May to 164,000 in August.

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The picture on inflation is somewhat more mixed. The monthly increase in the headline CPI was 0.2% (Reuters consensus: 0.2%), with a 0.3% figure in its core equivalent (Reuters consensus: 0.2%). The latter is a better gauge of medium-term price pressures. Another method to breakdown the CPI is into components that tend to change price often (Flexible) and those that tend to be slow-moving (Sticky). The former tends to more heavily reflect goods including commodities prices, while the latter will be more dominated by services. An update following August’s inflation print showed that the three-month annualised percentage change in Sticky CPI was 3.1% in August, up from 2.7% in July. Moreover, this figure has remained above 2% since March 2021. With Flexible CPI also showing signs of bottoming out, there is a case to be made that market expectations for a quick return to 2% inflation may prove misguided.

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While the FOMC is independent, policymakers will no doubt be weighing up the possible implications of November’s US presidential election. Prediction markets moved further in favour of Ms Harris, the Vice President, following this week’s debate, however, the race remains close to a coin toss. Neither candidate appears to desire much in the way of fiscal rectitude, with ongoing large deficits likely to put upward pressures on demand and prices. A Trump administration may have more of an impact here, given that if he wins it is more likely that such a victory will come with control of Congress, than is the case for his counterpart. Moreover, his proposals on large tariffs, if implemented, would be an additional shock relative to Ms Harris.

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We anticipate a 25 basis points cut, but will glean the accompanying statement, ‘dot plot’ and the Chair’s press conference for signs of how the FOMC judges the balance of risk between the labour market and inflation. So, while market participants appear to be more focused on the labour market, largely shrugging inflation data off, Fathom continues to see the risks to both inflation and interest rates to the upside.

The views expressed in this article are the views of the author, not necessarily those of LSEG.

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