Stocks and US Dollar at Risk as Markets Push Back Fed Rate Cuts

Markets are pushing back Fed rate cut expectations. That may spell trouble for stocks and the dollar.

• The Fed is firmly locked in wait-and-see mode, May FOMC minutes show.
• Markets seem no more certain of the economic outlook as key data looms.
• Repricing for a longer stimulus delay may punish stocks and the US dollar.

The Federal Reserve “well positioned to wait for more clarity” on inflation and the economy before acting on interest rates, according to minutes from May’s meeting of the central bank’s policy-steering Federal Open Market Committee (FOMC). Officials warned that uncertainty about the economic outlook is unusually elevated.

Participants in the conclave agreed that risks of higher inflation and higher unemployment have risen, noting that they may face “difficult tradeoffs” if inflation proved more persistent while growth and employment weakened. Almost all of them worried that inflation could prove to be more persistent than expected.

Where is the US economy really going now?

That broadly echoes the uncertainty prevailing in the financial markets. Analysis from the Fed’s Atlanta branch shows an unusually dispersed array of expectations for US economic growth in the second quarter, ranging from a decline of 1% to growth of 3%. The bank’s own GDPNow model is currently forecasting 2.2% based on the latest data flow.

From here, the personal consumption expenditure (PCE) measure of US inflation – the price growth gauge favored by Fed officials – headlines a slew of releases due to update the markets on the state for the world’s largest economy. The headline reading is expected to inch down to 2.2% year-on-year in April, the lowest in seven months.

The core measure excluding volatile food and energy prices – a focal point for the Fed – is expected to come down to 2.5%, the lowest since March 2021. Both measures are seen rising just 0.1% from the prior month, hinting at a third month of improvement in annualized 3- and 6-month averages monitored by central bank officials.

Fed rate cut delay may hurt stocks and the US dollar

Meanwhile, a second look at first-quarter US gross domestic product (GDP) data is expected to confirm preliminary estimates showing that output fell at an annualized rate of 0.3%. Revised consumer confidence data from the University of Michigan (UofM) is expected to reiterate that sentiment soured to the weakest since June 2022 this month.

This makes for a curious way forward. If not for the Fed’s reluctant posture, cooling growth and inflation might have made for an ideal recipe to resume cutting interest rates. Benchmark Fed Funds futures suggest nothing of the sort is on the menu until September however, and even then the probability of delay is a hefty 40.1%.

Traders have trimmed rate cut bets to just 40 basis points (bps) in cuts this year, amounting to the most modest setting for 2025 stimulus expectations in three months. The view for 2026 has grown more dovish however, with 60bps now on the menu. Put simply, the markets are angling for a delay that demands more forceful action later.

Absent a striking departure from consensus in the upcoming data, a further shift in the same direction may breathe some life into longer-dated US Treasury bonds as well as gold prices. Meanwhile, stock markets and the US dollar may retreat. Needless to say, all this presumes no shocking headlines from the White House, which may be a tall order.

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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