Markets Fear Recession More Than Inflation. Will the Fed Finally Listen?
Markets Fear Recession More Than Inflation. Will the Fed Finally Listen?
By:Ilya Spivak
The markets still think the Fed is wrong about interest rates. Which side will prove right?
- Fed Chair Powell keeps pushing back on rate cut urgency at ECB Forum.
- ISM manufacturing survey highlights worrying “stagflation” dynamics.
- The markets are at odds with the Fed on rates and calling for more cuts.
Federal Reserve Chair Jerome Powell stuck to a familiar script in remarks made at the annual European Central Bank (ECB) forum in Sintra, Portugal. The economy is in a “pretty good position” and inflation is “behaving as expected and hoped,” but for the tariffs rushed out by the Trump administration. They are expected to boost prices over the summer.
Powell repeated that a “solid majority” of Fed officials expect to be cutting interest rates this year, but while the economy is solid, it remains prudent to wait and size up whatever tariff-related price shock is ahead. He added that he “can’t say whether July is too soon to consider a cut,” but called the current setting of policy “modestly restrictive.”
US manufacturing data flags worrying “stagflation” patterns
A survey tracking the performance of US manufacturing from the Institute of Supply Management (ISM) seemed to underscore Powell’s worries. It showed that price growth in the sector accelerated in June to almost match the three-year high clocked in April. Overall, the data said costs grew at the fastest rate since mid-2022 in the second quarter.
The ISM report also highlighted the Fed’s concerns about the tariffs regime’s negative implications for economic growth. Manufacturing activity growth shrank for the fourth consecutive month as new orders and employment in the sector continued to fall, and at a faster rate. Job losses accelerated to the quickest pace in three months.
Benchmark Fed Funds interest rate futures have priced in 58 basis points (bps) in cuts this year and 68bps in 2026. The latter is a sharp departure from what officials wrote down in the latest Summary of Economic Projections (SEP) last month, which had just 25bps of stimulus next year. Traders and the central bank are broadly aligned for 2025.
The markets still do not believe the Fed on rate cuts
The probability of a cut in July is 21.2%, having hovered near 20% for the past month. It jumps to nearly 73% in September, pointing to that policy meeting as the start of this year’s easing effort. A second cut is narrowly favored by October, and the probability of a third one before the end of the year is tellingly just a bit better than even, at 55.8%.
The bond market echoes this thinking. Prevailing inflation expectations baked into Treasury pricing – so-called “breakeven rates” – have trended pointedly lower since mid-May. That suggests the markets are more worried about a disinflationary economic downturn than a sticky price shock from the tariffs.
From here, the service-sector ISM survey and June’s official US employment data are in focus. The former is expected to bring a modicum of sluggish growth in June following a contraction in the prior month. For the latter, economists have penciled in a rise of 110,000 jobs, which would be the smallest increase in eight months.
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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