Following the FOMC decision to keep rates unchanged in its July meeting, the market reaction – a plunge in stock prices for a couple of days – may have surprised Fed chair Jay Powell. Despite the sudden sharp reaction, I doubt it will change much of the FOMC’s opinion.
For now, the initial market tantrum seems to have subsided. The decline in long-term rates will likely relieve the financial markets until the September meeting. But we all need to remember that the Fed is a very conservative bunch, not wanting to steer the boat off course in a sudden movement without another more severe and pronged market meltdown. The Fed’s concern over taming inflation will still play an essential role in shaping their outlook for future rate cuts.
The Sahm rule, triggered last week after the jobs report, also raises the likelihood that the U.S. is in a recession. Even though some economic data related to the unemployment figures, as discussed by Sahm herself, suggest that this time could be different due to changes in immigration. However, the chances of recession have only been climbing, and even if the FOMC starts cutting rates every meeting by 25 bp, the effect of the policy change will only be seen in the data a few months from now. In the meantime, unemployment is more likely to keep rising, raising the possibility of a hard landing.
Following the FOMC meeting in late July, the markets have priced at 50 bp, which, at this time, seems unlikely (remember I said they are a conservative bunch).
The bottom line is that we shouldn’t expect the Fed to step in and start cutting rates aggressively. The Fed will likely cut rates by 25 bp in September, but 50 bp seems too much for this concentrative bunch. However, the recent decline in long-term yields and recovery in the stock market might provide some tailwind to the economy even as the FOMC contemplates its next move.