Will the Fed cut interest rates this summer?

Last week the US Federal Reserve (the Fed) chairman Jerome Powell went out to deliver a dovish message to markets, one to which they responded with enthusiasm. The Fed has come a long way since the fourth quarter (Q4) of last year, when regular hikes appeared to be a certainty, and investors fretted about how far the Federal Open Market Committee (FOMC) would go.

The heightened volatility of Q4 evidently spooked the Fed into responding, while trade wars are clearly beginning to worry Powell and his team. Data has also begun to weaken, and true to their pledge of being ‘data dependent’, the Fed has begun to move.

The US-Mexico standoff went away as quickly as it arrived last week, but we should probably assume that US President Donald Trump will employ these tactics again – tariffs are now a regularly-deployed weapon in his armoury, and given the US’ economic muscle, Trump will not be shy of trying to employ these tactics again, whether against China, Canada or Europe.

Jobs data shows weakened wage growth

Not only did Friday’s headline non-farm payrolls (NFP) miss forecasts, but the three-month average was dragged down to 151,000 due to downward revisions to the previous months. Wage growth has been weakening too, and this is perhaps the element that will bother the Fed the most.

Producer price index (PPI), consumer price index (CPI) and import prices this week will help provide more clues as to the outlook, as for the moment it seems most voting members are not ready to jump in the direction of more rate cuts. Retail sales and industrial production this Friday will give us further clues about the outlook too.

The jobs data outweighs the noise around the Mexico tariffs and their apparent resolution. Data is more important than the Trump’s tussles with foreign nations. At present, the weakness in some data, such as wages, is insufficient to support the view that a rate cut is necessary, since low unemployment should help to boost inflation to a degree. Despite running below their inflation target for so long, the FOMC does not deliberately look to overshoot inflation in order to balance out the picture. All they can do is wait to see if data begins to reduce upward pressure on inflation.

Upcoming FOMC meeting

We should watch for comments in the June FOMC meeting to see if Powell has managed to ‘persuade’ any others to come round to his view, in order to prepare the groundwork for a rate cut in the near future.

The best guide we have is 1995 – then the Fed reacted to weakening data by cutting rates three times in an eight-month period to stave off further deterioration. Perhaps the same approach will be employed here.