The Stock Market is at Risk if the Fed Continues to Push Back Rate Cuts

Prices hinge on FOMC minutes, Powell comments and economic data

• Financial markets are hinting the Fed is wrong to delay interest rate cuts.
• Leading data hints inflation is cooling, but are officials more confident?
• Stock markets now hinge on FOMC meeting minutes and Powell comments.

The Federal Reserve has been disappointed with the pace of progress on lowering inflation so far in 2024. In May, officials grumbled that, “in recent months, there has been a lack further progress toward [our] 2% inflation objective.” In June, they revised this year's policy forecast from three 25-basis-point (bps) rate cuts to just one.

The markets seem to have concluded this foot-dragging is wrongheaded. The rates path priced into in Fed Funds futures reveals that, while traders have broadly accepted the Fed’s one-cut view for 2024, they reckon that accelerated easing is on the menu for 2025 as the central bank scrambles to reverse course.

Stock markets cheered amid swelling 2025 Fed rate cut bets

Since mid-April, the readjustment of baseline expectations to reflect this view has seen the cumulative rate cut tally due by the end of next year expand from 77bps to 121bps. This dovish adjustment amounts to shifting from three to four fully priced-in 25bps rate cuts, with a 76% probability of a fifth one.

Stock markets cheered the change, with the bellwether S&P 500 pointedly turning higher after a month-long pullback to launch a ten-week rally. The stock index has added nearly 10% from the low set April 19. The move higher tellingly stopped two weeks ago, however, as the repricing process stalled.

Meanwhile, disinflation has picked up momentum. May’s consumer price index (CPI) data showed slower price growth than expected, with the core rate excluding volatile food and energy down to a three-year low of 3.4% year-on-year. The Fed’s preferred personal consumption expenditure (PCE) gauge marked an analog milestone at 2.6%.

Leading purchasing managers index (PMI) data hints that June marked another step in the right direction. Data from S&P Global had inflation at a five-month low. A parallel survey from the Institute of Supply Management (ISM) put manufacturing sector price growth at the softest since December.

Will renewed progress on inflation bring stimulus closer?

The service sector ISM report is due later this week. It is also expected to show price growth easing. The growth rate in average hourly earnings—a measure of wage inflation and a key input into the Fed’s calculus—is seen coming down to 3.9% year-on-year when it is published alongside the monthly jobs report on July 5.

The top question now seems to be whether the Fed is prepared to endorse such outcomes.

If policymakers signal their confidence in a timely arrival at the 2% inflation target has increased, traders may reckon that a rate cut could arrive sooner than currently expected. That seems likely to be cheered by stock markets. Alternatively, opting to remain in “wait and see” mode will probably be met with disappointment.

This week, the release of minutes from June’s meeting of the rate-setting Federal Open Markets Committee (FOMC), as well as a speech by Fed Chair Jerome Powell at the annual ECB Central Bank Forum in Sintra, Portugal, will mark key waypoints in this story.

The mood on Wall Street will probably brighten if the minutes document suggests Fed officials did not take May’s soft CPI data into account—leaving room for a dovish rethink—and Mr. Powell strikes a more optimistic tone. Otherwise, displeasure with ongoing stimulus delay might push markets downward.

Ilya Spivak, tastylive head of global macro, has 15 years of experience in trading strategy, and he specializes in identifying thematic moves in currencies, commodities, interest rates and equities. He hosts Macro Money and co-hosts Overtime, Monday-Thursday. @Ilyaspivak

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