Explainer: Key Contour Lines Around FOMC’s Looming Decision

The US Federal Reserve is poised to conclude its policy meeting on July Thirty First, with Chair Jerome Powell expected to discuss the central bank’s rate latest decision. This meeting is seen by most analysts as a warm-up act for September, as many Wall Street analysts are hoping for insights from FOMC members that bolster their view of a cut in September.

Economists predict that the Fed will likely announce a rate cut in July, as inflation continues to cool. However, it is unlikely that the Fed will announce a rate cut this week because Powell wants to see more proof that inflation is closer to the bank’s goal of a 2% annual rate before trimming.

Markets are still betting on more than a single rate cut in 2024, even though Fed officials earlier this year projected just one rate cut later in the year. Futures markets have priced in a 64% likelihood that the Fed will cut rates three times this year — in September, November, and December.

The federal funds rate, which banks charge each other for short-term loans, is currently positioned in a range of 5.25% to 5.5%. Most economists expect the Fed to leave that rate unchanged until its September meeting.

Economists are penciling in a Fed rate cut of 0.25 of a percentage point in September, which would trim the benchmark rate to a range of 5% to 5.25%. If that goes well, we could even see two additional 25 basis point cuts before 2024 comes to an end. However, cuts are far from guaranteed, as the Fed is designed to pivot quickly should something unexpected happen.

Balancing Act

The Fed’s rate decision is based on its dual mandate — keeping prices stable and ensuring maximum employment. Inflation continues to cool, reflecting that the prices of goods and services are rising at a progressively slower rate since their 2022 peak.

At the same time, the Fed is closely watching employment data. Some economists and policy experts believe the Fed has already waited too long to cut rates, citing weakening job numbers and cooling inflation.

The Fed is under pressure to balance its dual mandate of maintaining maximum employment, stable prices, and moderate long-term interest rates with the need for full employment. However, this dual mandate has led to mixed data and mixed messages regarding the impact on interest rate cuts. The Fed’s policies are sequential, with price stability being a prerequisite for providing labour market support. The upcoming July meeting is likely to be the last where price stability considerations dominate, with labour market concerns transitioning to the forefront of Fed policymaking in September.

Economic Indicators, Geopolitical Shocks

The June Consumer Price Index shifted the burden of proof in the inflation debate, making it unreasonable to maintain higher-for-longer interest rates to achieve price stability in an economically relevant time horizon. However, there are risks to the inflation forecast, such as continued volatility in monthly price data and the U.S. economy remaining vulnerable to policy and geopolitical shocks.

After peaking at 9.1% in June 2022, the base rate is currently at a more than two-decade high as the Fed fights inflation. Powell’s job was to ensure that the U.S. economy had a “soft landing” in the face of significant fiscal stimulus from the Biden administration, inflationary geopolitical variables like the war in Ukraine, and price increases without going into recession.

The relative comfort on inflation should give the Fed room to shift to the second half of its dual mandate, the goal of full employment. The picture is mixed, with payrolls continuing to grow at a solid clip, with over 200,000 jobs created in June 2024 alone. However, the unemployment rate shifted higher, topping four percent for the first time since late 2021.

The household survey shows nearly four million fewer jobs in the U.S. than reported by employers, which can point in different directions. The Bureau of Labour Statistics (BLS) has a robust statistical approach to account for these differences, but the close relationship has broken down over the past two years. Adjusted household data from June shows nearly four million fewer jobs in the U.S. than reflected in the employer data.

Jobs in Focus, Sahm Rule

One factor experts will be watching is jobless claims. Claims have stabilized and are now within touching distance of breaching the Sahm Rule. The Sahm Rule looks at two factors: the current three-month moving average of US unemployment and the lowest three-month moving average of US unemployment over the past year. If the current average is higher than the lowest average by more than half a percentage point, the American economy is headed for a recession.

The labour market is likely softer than reflected in headline payroll growth. The trend in inflation data and the Fed’s dual mandate give the central bank the latitude to consider cuts as early as tonight’s meeting.