Source: Jin10 Data

The market has begun a battle that most participants believe they could never win. Although the Fed has emphasized that it is not yet ready to declare victory against inflation, investors are betting that the Fed may implement the first of two rate cuts this fall.

After a two-day meeting in Washington, the Fed kept its benchmark lending rate between 5.25% and 5.5%, the highest level in over 20 years. A mild inflation report showed that price pressures in the world's largest economy eased in May.

Fed Chairman Powell told reporters at a post-rate-decision press conference, "Most" Fed officials were unmoved by the slowest monthly inflation increase in four years and the lowest inflation data since 2021. The graph shows that the Fed will only cut interest rates once this year, while the March forecast was three rate cuts. Officials expect inflation pressures to pick up slightly in the second half of this year.

Powell told reporters, "We have stated that we don't think it's appropriate to lower interest rates until we have greater confidence that inflation is moving towards our 2 percent objective. The data so far this year haven't given us that confidence. However, recent inflation data have been more favorable than earlier in the year, and have shown some modest further progress toward our inflation goal," he added. "We need to see more good data before we can have greater confidence that inflation is on track to reach our 2% target."

The decline in PPI data may reassure some Fed officials, as the data will eventually be included in the PCE price index favored by the Fed. The May core PCE month-on-month growth rate is essentially the same as in April, while the overall PCE month-on-month growth rate actually fell 0.2%.

Ian Shepherdson of Pantheon Macroeconomics said that weak PPI and CPI data in May could mean that the month-on-month growth rate of core PCE price index in May will only be 0.1%, far below the average of 0.32% for the first four months of this year.

He added, "Meanwhile, slowing rent increases, falling wage inflation prospects, and the prospect of squeezed retailer profit margins suggest that the underlying PCE price index will continue to rise at a slower pace than the Fed expected this week, laying the foundation for the first rate cut in September and multiple rate cuts this year."

Cracks in the job market

The US Labor Department's report on weekly applications for unemployment benefits seems to at least partially confirm cracks in the US labor market. The latest data show that the number of initial claims for unemployment benefits in the week ending June 8 was 242,000, an increase of 13,000 from the previous week and the highest since August of last year.

Following the stronger-than-expected release of May non-farm payroll employment data last week, rate traders suffered a setback in their bet that the Fed would cut rates in September. After Thursday's data, they rekindled hopes of a fall cut.

The Chicago Mercantile Exchange's Fed observation tool currently shows a 67.7% probability of a 25 basis-point rate cut by the Fed in September.

David Russell, global head of marketing strategy at TradeStation, said, "As inflation cools, initial jobless claims indicate cracks in the labor market. The Fed has been hawkish all along, but they must be careful in the final battle. The reason for dovishness is emerging. Policymakers have lagged the curve in fighting inflation in 2021, and we can only hope they won't do the same in 2024."

This once again goes against the Fed's forecast for June. Against the backdrop of the S&P 500 and Nasdaq indices repeatedly hitting new highs and US Treasury yields hitting multi-month lows, this has brought investors entering the summer another dilemma of "not to confront the Fed".

Continuing to confront the Fed

Chris Larkin, managing director of trading and investing at Morgan Stanley E-Trade, said, "Every piece of data that falls into the 'inflation moderation' category will increase the likelihood of a Fed rate cut by the end of the year. But as we've seen, the Fed doesn't tend to overreact to one month's worth of data."

Chris Zaccarelli, Chief Investment Officer at Independent Advisor Alliance, said the Fed's main impact on the market right now is the sudden shift of signals from rate cuts to rate hikes, but "they haven't shown any signs of doing that. Ultimately, the stock market won't be affected by the Fed prolonging its rate cut nodes and will continue to expect rate cuts. The May CPI data further strengthens the view that the Fed's next move will be to cut rates, either at the end of 2024 or early in 2025. Therefore, it is expected that the market will continue to set records in the near future."

If the Fed chooses to cut rates in September as the market is betting, it will mark the end of the longest interval (420 days) between the Fed's last rate hike and its first rate cut.

Jeff Buchbinder, chief equities strategist at LPL Financial, cited data collected over the past 50 years to point out that during the Fed's pause in raising interest rates, the S&P 500 index has averaged a 6% increase.

However, the stock market seems to benefit from longer pauses, Buchbinder said, with the average return on the last six "policy pauses" since 1989 slightly higher than 13%.

Since the Fed raised interest rates on July 26 last year, the broadest blue-chip stock benchmark index in the United States has risen more than 13.5%, while the tech-heavy Nasdaq index has risen 24.8%.

According to Clark Bellin, the CEO and CIO of Bellwether Wealth, there will be even more gains in the future as the market looks towards a world of anti-inflation and sustained corporate profit growth. "The stock market is forward-looking, and despite inflation still at high levels, it is anticipating a period of lower inflation," he said:

"The stock market is forward-looking, and despite inflation still at high levels, it is anticipating a period of lower inflation."

Editor / jayden