U.S. economic outlook weakening overlapping inflation slowdown JPMorgan Asset Management: Fed rate cuts as early as September

By: jack May. 05,2023
On Wednesday, the Federal Reserve raised its target range for the federal funds rate by 25 basis points to between 5% and 5.25%, as expected. This is the central bank's tenth consecutive rate hike since March 2022 to fight inflation. With this hike, the level of the U.S. benchmark interest rate is near its pre-financial crisis peak in 2008.

  "People did talk about a pause in rate hikes, but not as much at this meeting." Fed Chairman Jerome Powell said at a press conference after the policy meeting, "We feel we're getting closer to the target, maybe even reaching it."

  JPMorgan Asset Management fixed income portfolio manager Jason Davis said the Fed has ended its rate hike cycle and will begin cutting rates as early as September of this year.

  The end of the rate hike cycle?

  Analysts believe that, compared with the previous statement, the May monetary policy statement removed the wording "the Committee expects that some additional policy tightening may be appropriate" and replaced it with "in determining the appropriate degree of further policy tightening, economic conditions will be carefully monitored as well as the impact of rapid rate increases over the past year. The change implies that the current rate hike cycle may have come to an end.

  In its statement, the Federal Open Market Committee said, "In determining whether further rate increases are needed in order to return inflation to the 2 percent target over time, the MPC will consider the cumulative degree of monetary policy tightening, the lagged impact of monetary policy on economic activity and inflation, and economic and financial developments." These statements are the same as those used by Fed officials when they stopped raising interest rates in 2006. At the June 2006 meeting, the Fed removed the phrase "further policy tightening may be needed" from the policy statement and adjusted the language around the "extent and timing" of further tightening that might be needed.

  Meanwhile, at a press conference after the statement was released, Powell said, "I think monetary policy is already in a tightening position." But he also added, "If necessary, we are prepared to further tighten monetary policy."

  Mark Zandi, chief economist at Moody's Analytics, said, "He can't promise a pause, but he almost did that."

  For his part, Davis said, "In our view, the rate hike cycle is definitely over."

  He explained: "The reason comes from two sides, that is, the Fed's two core tasks: growth, last year when Europe responded to the huge energy shock, the U.S. economy showed considerable resilience, but now looks very fragile; we see the leading indicators are sending signals that the U.S. economy is heading for recession. And on the inflation side, we think inflation is slowing rapidly and will maintain that trend; for example, average hourly earnings have reached their target level."

  "Our view is that inflation has reached a turning point. If you look at the breakdown, prices of core goods have fallen sharply and should fall further, housing inflation has finally come down, and the rest of the items are more volatile, but also on the downside." He said.

  The time to cut interest rates is near?

  The market expects the Fed to start taking action with three interest rate cuts this September, but Powell countered expectations of a rate cut this year at a news conference. Powell said the Federal Open Market Committee believes that inflation will not fall as fast, and if that forecast holds, then a rate cut would be ill-timed.

  "They're not going to talk about cutting rates yet and declaring success in the fight against inflation." Davis said, "But if you look back at previous tightening cycles, you'll see that the time between the last rate hike and the first rate cut is usually six to seven months."

  "We actually think this one could be a little earlier because we are in the most aggressive tightening cycle since the 1980s, so we think a rate cut could come as early as September." He said.

  According to CME Group's FedWatch tool, as of May 4, the probability of the Fed cutting rates at the September policy meeting was more than 85 percent.

  However, as stated in the latest monetary policy statement, the U.S. "inflation remains at a high level" and job growth is still "at a strong pace", despite the weakening economic outlook, the risk of upward inflation still makes the Fed's late interest rate path variable.

  Data released by the U.S. Department of Commerce on Friday showed that the Fed's favored inflation indicator - excluding food and energy prices, the core personal consumption expenditure deflator (PCE) - rose 4.6% in March, compared with a revised previous value of 4.7%. The decline was less than economists had expected.

  Harvard economist and former economic adviser to the Obama administration Jason Furman (Jason Furman) said, "Inflation will always have at least some temporary element, and eliminating underlying inflation is much more difficult."

  The Fed has vowed to prioritize the restoration of price stability even at the expense of economic growth, so now the Fed has more work to do. Furman noted that among the main indicators of monetary policy tightening as perceived by economists, few showed a significant deceleration, with factors such as rising wages, construction employment and credit spreads all looking quite strong.
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