The Prospects for U.S. Interest Rates

The U.S. Federal Reserve has spent 2024 pausing any monetary policy changes after increasing the short-term Fed Funds Rate from zero in early 2022 to a midpoint of 5.375%. While the Fed has trimmed its monthly quantitative tightening starting in June 2024, reducing upward pressure on interest rates further along the yield curve, the short-term rate has remained higher for longer than many market participants expected.

The most recent jobs report showed unemployment rose to 4.1%. In his testimony before the U.S. Senate and House of Representatives, Fed Chairman Jerome Powell indicated that the jobs market could set the stage for a rate cut. Still, the FOMC is waiting for more data showing inflation is falling towards the central bank’s 2% target. Chairman Powell has repeatedly stated that inflation does not have to reach 2% before the Fed begins cutting rates, but it must be heading in that direction.

June CPI Cools

• The June consumer price index increased 0.1% monthly and 3% from the prior year, which was lower than the market had expected and the lowest level in three years.
• The core CPI, excluding volatile food and energy prices, rose 0.1% and 3.3% from last year. The annual increase in core CPI was the lowest since April 2021.
• The cooler CPI supports a 25 basis point rate cut at the September FOMC meeting as CPI has trended lower since the 2022 high at 9%.

June PPI was a bit hot- Awaiting the Fed’s favorite indicator

• The June producer price index rose 0.2%, slightly higher than the market had expected.
• The May data was lower than expectations, but the Bureau of Labor Statistics revised May’s PPI marginally higher.
• The Fed and markets will now wait for the central bank’s favorite inflation index, the PCE, which comes out in late July.
• The slightly hotter PPI likely means the Fed will continue to pause until September, waiting for further data before a 25 basis point rate cut. 

The election- A pause as the Fed awaits the policy path

• The November 5 U.S. election remains highly contentious and a close contest with vastly changing dynamics.
• The Fed is an independent body that is not likely to make any significant monetary policy changes until after the election to avoid the appearance of favoring either candidate.
• Expect the Fed to pause throughout the summer, with a nominal 25-point reduction in the Fed Funds Rate in September. Any significant monetary policy changes are likely after the election. 

Rates will fall- How much and how fast depends on three factors

• Factor one: Inflation data must show progress towards the 2% target level for the Fed to pivot from hawkish to dovish.
• Factor two: Future interest rate cuts are a function of the unemployment rate, as the Fed’s mandate is stable prices and full employment.
• Factor three: Domestic U.S. politics and geopolitics are significant issues that will likely cause an economic rollercoaster over the coming months.
• Finally, as we learned in 2008, 2020, and 2022, unexpected events always cause the most market volatility and the Fed to respond to emergencies.

Positioning for rate cuts

• Rate cuts are historically bullish for stocks. The SPY ETF tracks the most diversified U.S. stock market index, the S&P 500.
• Rate cuts support higher commodity prices as they reduce the cost of carrying raw material inventories. The DBC or its no-K-1 partner, PDBC, owns a diversified portfolio of commodities.
• Higher rates translate to lower bond prices. The TLT ETF product moves higher as long bond prices decline.

The June CPI and PPI data mean the Fed will wait for validation that inflation remains on a path toward its 2% target from the June PCE data. The odds of a 25 basis point decline in the Fed Funds Rate remain high for the September FOMC meeting. However, any significant monetary policy pivot will likely wait until 2025 as the November election is a roadblock for the central bank.

Thanks for reading, and stay tuned for the next edition of the Tradier Rundown!