Source: Wall Street News

The resurgence of US inflation has seriously dampened expectations for the Fed to cut interest rates recently. As of press release, the CME Fed observation tool shows that the market will not face the first rate cut by the Federal Reserve in the coming year until September of this year.

Goldman Sachs chief economist Jan Hatzius believes that the recently released high inflation data is only a special phenomenon. Currently, several factors driving the downward inflation rate are still stable. It is expected that the next inflation data will be more moderate, so the forecast for interest rate cuts in July and November is maintained.

The US election (voting day for this year's election is November 5) may have a certain impact on the Fed's policy, but Hatzius pointed out that the Fed's policy path still mainly depends on economic indicators, especially whether the inflation rate continues to fall to the target level of 2%. The team led by Hatzius wrote in the May FOMC forward-looking report released last weekend:

We don't think the upcoming election is critical to the timing of the first rate cut. Since the 1980s, there has been little evidence that the FOMC will implement a different monetary policy before the presidential election.

Furthermore, in the current situation, Federal Reserve officials may face criticism from politicians if they choose to cut interest rates on the eve of the election or keep the federal funds rate high.

Goldman Sachs also stated in the report that the possibility that the Federal Reserve will raise interest rates is quite small. The reason is that currently the labor market and inflation are actually showing no signs of heating up again, and fund interest rates are already quite high.

The report points out that interest rate hikes will only become a reality if global supply is severely impacted, or if fiscal policies cause inflation to soar.

Even under these circumstances, the FOMC may be more inclined to stabilize fund interest rates at a high level, unless these shocks seem likely to trigger broader and more lasting inflation problems.

Goldman Sachs believes that if inflation continues to run at a high level, the Federal Reserve may limit or delay interest rate cuts, or even postpone them until after next year.

Housing, healthcare, and car prices may continue to slow, driving inflation downward

Goldman Sachs believes that the high inflation data released recently is only a special phenomenon; currently, several factors driving the downward trend in the inflation rate are still stable.

First, housing costs are likely to be rising at a slower pace, and the impact on overall inflation may be weakening. Specifically, the housing inflation index according to official statistics is gradually declining, which is in line with the downward trend of market-leading indicators.

Second, health care and auto insurance prices are subject to regulatory restrictions, so changes in these prices may not immediately reflect changes in the supply and demand relationship in the market. Once these lagging price increases are incorporated into the price system, these regulated prices may not continue to grow at the same rate unless there is new upward pressure on costs. This may also indicate that although prices in these categories have risen in the recent reporting period, they may not exert continued upward pressure on the overall inflation rate in the future.

As competition intensifies, the supply shortage of automobiles and other goods is likely to end, which will cause corporate profit margins to fall, thereby helping to reduce inflationary pressure.

Furthermore, market and household inflation expectations are likely to remain stable, which helps prevent inflation expectations from rising, thereby supporting the trend of deflation. A slowdown in global economic growth or other international factors could put downward pressure on US inflation.

If inflation continues to be high, shouldn't we expect interest rate cuts during the year?

Goldman Sachs pointed out that its basic forecast is that the inflation rate will drop to 2%, so the Federal Reserve will continue to cut interest rates to normalize fund interest rates. The key question is the definition of “normal” — how will the FOMC rethink neutral interest rates.

The report mentioned that the interest rate level recommended by the FOMC's monetary policy rules presented at the conference is generally lower than the FOMC's current interest rate level. This indicates that the FOMC may adjust its estimate of neutral interest rates based on economic conditions and inflation trends.

Goldman Sachs continues to believe that the FOMC will not want interest rates to stay at 5.25-5.5% indefinitely, although it may decide where to stop is still quite uncertain. Goldman Sachs currently expects a final interest rate of 3.25-3.5%.

If, on the contrary, inflation remains high, either because it is more sticky than we expected, or because new shocks appear, then interest rate cuts may be more limited or delayed, or even beyond next year.

For example, if large-scale tariff policies significantly boost the CPI inflation rate, then the Federal Reserve may not cut interest rates even until next year.

edit/lambor