Source: Zhitong Finance Author: Rousseau

The prospect of the Fed cutting interest rates may face major adjustments triggered by a rekindled risk of inflation. The US economy continues to withstand calls for an economic slowdown and hints that it is about to fall into a slight recession, and the resilience of the job market and strong consumer spending data continue to fuel stronger than expected economic growth prospects.

However, this unexpected economic strength has heightened people's concerns that the US Federal Reserve, which is focused on fighting the stubborn rate of inflation, may continue to postpone interest rate cuts over the next few months, and may not cut interest rates throughout the year. According to some economists who are cautious about US inflation and some US Federal Reserve officials who take a “hawkish” stance, the possibility of raising interest rates for the rest of the year to combat stubborn inflation is not even ruled out.

Currently, there are two Wall Street investment institutions — Jefferies (Jefferies) and Mizuho — and the Federal Reserve is not expected to cut interest rates during the year. Furthermore, Shaan Raithatha, a senior economist from Pioneer Group, a top US asset management company, said the agency's basic assumption is that the Federal Reserve will not cut interest rates in 2024. Torsten Slok, chief economist at Apollo Global Management (Apollo Global Management), predicts that the Federal Reserve is likely to keep the benchmark interest rate unchanged for the rest of 2024.

What is even more alarming news for investors is that the minutes of the US Federal Reserve's May policy meeting released last week show that some Fed officials emphasized that the Federal Reserve is willing to “further tighten policy” if the risk of inflation becomes a reality again. However, more officials still suggest that when deciding on recent interest rate trends, they tend to “wait and see,” that is, keep current high interest rates stable.

Federal Reserve Governor Michelle Bowman (Michelle Bowman) said in a recent speech that she expects US inflation to remain high for a long time, and reiterated that the possibility of restarting interest rate hikes if necessary is not ruled out. “Although the current monetary policy stance seems to be at a restrictive level, I am still willing to adjust the federal funds rate target range at future meetings if the upcoming data shows that progress in the fight against inflation has stagnated or reversed.” Bauman said.

After the next Federal Reserve policy meeting on June 12, Fed officials will release new economic growth and inflation forecasts, as well as the interest rate bitmap that the market is most concerned about. The market is preparing for a major adjustment by the Federal Reserve to cut interest rates three times this year, as suggested by the previous version of the bitmap. Interest rate futures traders are betting that interest rates may only be cut once for the rest of the year. Generally, November has the highest probability, followed by December; the possibility of two interest rate cuts throughout the year is less than 50%, which is significantly smaller than the probability of about 70% in early May.

In fact, some traders are betting that the Federal Reserve will not cut interest rates throughout the year, unless there is a sudden sharp decline in non-farm payrolls data or an increase in external shocks related to geopolitical risks. These bets can be described as reflecting the continued strong performance of the US economy, and the upcoming November presidential election, which is expected to stimulate economic growth.

According to the S&P Global (S&P Global) benchmark PMI survey released late last week, the composite PMI for May hit a two-year high. Among them, service sector PMI grew at an accelerated pace and manufacturing PMI strengthened moderately. Most importantly, some PMI segments for services and manufacturing suggest that US inflation is heating up. For example, factory input prices are rising the fastest since November 2022, and the prices paid and received by service providers are also increasing.

Notably, the latest US PMI data shows that the main driving force for inflation now comes from manufacturing rather than services, and shows that costs and sales prices in both industries have risen, indicating that the Federal Reserve's last-mile process to fight inflation has almost come to a standstill, which helps explain why the Federal Reserve plans to keep interest rates at a high and restrictive level for a longer period of time.

The durable goods order data for April was better than expected, rising 0.7%, higher than the 0.8% decline generally expected by the market, confirming to a certain extent the possibility of a rebound in inflation. PMI data and durable goods orders also showed that the pace of US manufacturing activity maintained a solid growth momentum in the second quarter.

According to the Atlanta Federal Reserve's GDPNow forecast tool updated on Friday evening, the US economic growth rate for the current quarter is expected to be 3.5%, which is more than double the 1.6% expected growth rate for the first quarter of this year.

Stubborn upward pressure on prices

In the S&P Global PMI report, the price classification index paid by US companies to wholesalers rose to its highest level in more than 18 months, indicating that inflationary pressure may continue until this summer. “Increased business confidence indicates a brighter outlook for the year ahead,” said Chris Williamson, chief business economist at S&P. “However, due to the uncertainty of future inflation and interest rate trends, companies remain cautious about the economic outlook and continue to express concerns about geopolitical instability and the presidential election,” he added.

Meanwhile, data from the US Department of Labor shows that since the fall of last year, there has been the biggest continuous decline in the number of people applying for unemployment benefits each week, and the four-week average remained around 220,000, far below the long-term average of 345,000 people before the COVID-19 pandemic in 2020.

According to a consumer confidence survey closely followed by the University of Michigan, the US inflation forecast for the full year of May fell to 3.3%, while overall financial optimism improved slightly.

“The Federal Reserve believes that the risks to the economic outlook are broadly balanced, so inflation must be convincingly mitigated before starting to cut interest rates.” Jeffery Roach, chief analyst at LPL Financial, said. “We know from the University of Michigan's final estimates that consumer spending may slow, which may ease inflationary pressure on economic demand.” he added.

Interest rate traders have long been unoptimistic about the possibility that the Fed will cut interest rates in the summer, but they had hoped that the Fed would cut interest rates for the first of the two expected in September. Stronger PMI data and more optimistic initial jobless claims reduced expectations for the September rate hike to less than 50%, the lowest level in weeks.

Goldman Sachs's attitude towards predicting interest rate cuts has taken a big turn

In fact, Wall Street bank Goldman Sachs cancelled the forecast evaluation of the July interest rate cut. This is a significant anomaly in Wall Street's forecast, and added that there will be another four CPI reports before the September meeting. Goldman Sachs said, “If the average monthly core CPI is high (0.2% range) and core PCE is low (0.2% range), as we expected, then we think most FOMC participants will support interest rate cuts.”

However, Goldman Sachs continues to maintain the forecast that the Federal Reserve will “cut interest rates every quarter or every two meetings,” which means that the timing of the second rate cut was completely postponed from October to December, as previously anticipated by Goldman Sachs. Goldman Sachs's expectation that the Federal Reserve will cut interest rates twice in total in 2024 remains unchanged, rather than the rate cut of more than 100 basis points expected by Goldman Sachs at the beginning of the year.

After that, the next Federal Reserve monetary policy meeting is scheduled to be held on November 7, and the last meeting of the Federal Reserve this year is scheduled to be held on December 18. These points coincide with the US election period.

Others noted the weakness of some labor-market data, as well as a slowdown in recruitment in April. These analysts believe that the Federal Reserve may be forced to cut interest rates as soon as possible to avoid a sharp rise in the overall unemployment rate.

Ian Shepherdson, an analyst at Pantheon Macroeconomics, emphasized the weakening trend in the employment index associated with the S&P Global (S&P Global) May employment report. He said that the report “employment growth was significantly weaker than in recent months,” and hinted that companies expected demand growth to weaken.

“Meanwhile, the output price index shows that anti-inflationary pressure continues,” he added. “All in all, the survey shows that employment and inflation data will weaken in the coming months, enabling the Federal Reserve to start cutting interest rates in September.”

Alex McGrath, chief investment officer of NorthEnd Private Wealth in Greenville, South Carolina, believes that as the US enters the election cycle, an even greater concern will arise. “The well-known predicament and difficult situation that the Federal Reserve wants to avoid is coming,” he warned. He also added that due to the slowdown in economic growth and persistent high sticky inflation, these cannot be compared to interest rate cuts. “For the US Federal Reserve, which thought inflation was a temporary phenomenon two years ago, the stagflation situation would be a very bad situation, and cutting interest rates should not be something to consider now.”

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