Inflation Is Falling Nicely, So When Will the Fed Cut?

Inflation’s downward tick in June, by 0.1%, is a boost for investors who believe that the Federal Reserve will be free to start cutting interest rates as early as its September meeting—despite the odds that inflation likely will remain higher than the Fed’s 2.0% rate cutting target.

The latest Consumer Price Index reading, released Thursday, was 3.0% year over year, which continues its descent from its 9.1% level in June 2022, during the rebound from the pandemic.

But Fed Chair Jerome Powell and the central bank’s policymaking Federal Open Market Committee use another inflation measure, the Personal Consumption Expenditures index, which rose 2.6% in May (the June number comes out July 26). The PCE, though, has been stuck at that level for a number of months and getting it down to 2.0% soon might be problematic.

In congressional testimony earlier this week, Powell placed emphasis on a slowing labor market, in addition to cooling inflation, as guiding future monetary policy decisions. He no longer mentions a precise inflation target as the objective to reach before dropping rates.

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Certainly, predictions are widespread that policy easing will start soon, although not as soon as the July 31 FOMC meeting, The odds of a quarter-point cut at the following meeting, on Sept. 18, are 84.6%, per the CME Group’s futures, down from the present federal funds rate, a 5.25% to 5.50% band. By year-end, the CME betting is that rates will be down 75 basis points from current levels.

Strategists concur. “Our base case is still a half point cut in December, but we now think there is a decent chance for a September cut,” wrote Bryce Doty, senior portfolio manager at Sit Investment Associates, in a research note.

In the view of Andy Schneider, senior U.S. economist at BNP Paribas, “We now expect two 25 bp cuts this year (in September and December), and the quarterly cadence continuing through 2025, bringing end-2025 fed funds to a 4.0% upper bound.”

To Lindsay Rosner, head of multi-sector investing at Goldman Sachs Asset Management, “The economic data heat wave seems to have subsided as we are getting cooler inflation data on the heels of cooler labor market prints last week. Cooler temperatures forecast a Fed cut in September.”