President Donald Trump continues to criticize the Federal Reserve, saying this weekend that if the central bank “knew what it was doing” it would cut rates.
But, despite the president’s wishes, the decision on whether to reduce rates at this month’s Federal Open Market Committee meeting remains finely balanced:
- Ahead of this week’s semi-annual testimony to Congress by Fed Chair Jerome Powell, the Fed has published its Monetary Policy Report (MPR), which sheds light on the central bank’s reaction function. The report attributes only a small proportion of the slowdown in global growth and trade volumes to the direct impact of tariffs, highlighting instead the impact of uncertainty over trade policy on manufacturing, trade, and investment. According to the Fed, this year’s decline in Treasury yields, “largely reflects investors’ concerns about trade tensions and the global economic outlook.” This focus on uncertainty supports our view that the Fed will lower rates pre-emptively to stave off the risk of a growth slowdown.
- Friday’s non-farm payroll report showed that US jobs growth rebounded to 224k in June from May’s surprisingly weak figure (revised to 72k). Annual growth in average hourly earnings remained moderate at 3.1%. The strong data prompted a sell-off in Treasuries as markets scaled back expectations for Fed action, with US two-year yields rising 10 basis points (bps) on Friday, the largest one-day gain in six months. The strong rebound in jobs raises the bar for a Fed rate cut at the end of the month.
- US inflation data for June is also due this week. Consensus expectations are for the core annual rate to remain at 2%. Inflation expectations have been falling in recent months. While Friday’s strong labor market data sparked a rebound, 10-year US inflation breakevens remain at 1.69%, comfortably below the Fed’s 2% inflation target, which gives the central bank scope to lower rates.
With two days of testimony from Powell, the release of the minutes from the June FOMC meeting and several other Fed officials speaking, this week will provide plenty of input on the Fed’s thinking. While by no means a done deal, our base is still that the Fed will cut rates pre-emptively in July. However, even after Friday’s reaction to the strong jobs data, markets are pricing close to 100bps of rate reductions by the end of next year. We think markets have gone too far in pricing lower rates, and prefer stocks and cash over shorter-maturity US government bonds.
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