Powell: Wait, wait a little longer!

In the overnight market, the heavyweight US CPI data shows that inflation has significantly fallen, with the core CPI in May dropping to a three-year low year-on-year. On the same day, the Federal Reserve's interest rate decision remained unchanged as expected, but the decision statement acknowledged the progress in inflation. Market expectations for a rate cut in September have increased, with the S&P and Nasdaq hitting new highs.

However, during the post-meeting press conference, Federal Reserve Chairman Powell still emphasized that the inflation data so far this year is not enough to give the Fed confidence to cut rates, requiring more data to boost confidence.

Wall Street analysts pointed out that the cooling of the job market and the current restrictive monetary policy are pushing inflation steadily downward. However, the Fed's dot plot still indicates that there will only be one rate cut this year. From Powell's signals, the Fed remains undecided on the interest rate policy path, with the FOMC believing that the May CPI is just a single data point, and their views will change with more data in the future.

The dot plot showing only one rate cut this year completely surprises Wall Street

Deutsche Bank pointed out in a report that the Fed unexpectedly indicated in the dot plot at this meeting that there will only be one rate cut this year, lower than the three cuts in March. Analysts emphasized that although Powell did not emphasize this hawkish signal, he did deliberately downplay the weak CPI data released on the same day, only mentioning "welcoming today's CPI data and hoping to see more data like this."

Analysts at Bank of America also believe that the dot plot showing only one rate cut this year is "completely unexpected," as the bank originally expected the dot plot to show at least two rate cuts. However, the meeting statement and Powell's speech show a mild dovish tendency:

"Today's inflation data is a welcome sign, indicating that the US economy is capable of growing at a moderate to steady pace while inflation slows down. The next step should be a rate cut, but when to cut rates is still up for debate. Our view is that the rate cut will be later than what the current financial markets are pricing in."

However, Deutsche Bank pointed out that although the dot plot shows that most FOMC members at the June meeting expect only one rate cut this year, the bank believes that most officials usually do not adjust their forecasts on the day of the meeting. In other words, the dot plot may not accurately reflect the impact of the May CPI data. Analysts believe that the soft inflation data in May still opens the door for a rate cut before the November election, but Deutsche Bank's baseline forecast remains one rate cut in December.

Bank of America also stated that the Fed still maintains its unchanged economic growth outlook, which also surprised analysts, as the bank originally predicted that the Fed would lower its economic growth forecast for this year.

At the June meeting, the Fed also raised the overall and core personal consumption expenditure inflation forecasts for 2024 by 0.2 percentage points to 2.6% and 2.8%, respectively. The inflation rate for 2025 was raised to 2.3%. Bank of America believes that these forecasts indicate that the Fed can implement restrictive policies for a longer period to achieve its macroeconomic goals.

Interest rate decisions are not only based on inflation but also on overall data including employment and economic growth

Deutsche Bank also noted that Powell mentioned in his speech that the interest rate decision is not only based on inflation but also on "aggregate data," including labor market and economic growth data.

Analysts wrote:

He (Powell) believes that these data may send important signals, indicating that the economic conditions align with a sustainable return to the 2% inflation level. This framework is noteworthy because it suggests that if inflation progresses significantly but the labor market and economy continue to perform strongly, the Fed may choose to maintain rates unchanged for a longer period.

From the wording of the speech, Powell's description of the economy and labor market has some hawkish elements. He referred to the economy and labor market as "strong" or "robust." In terms of growth momentum, Powell pointed out that while they see some evidence of pressure on low-income households, overall consumer spending remains strong.

In terms of the labor market, despite emphasizing that "a range of broad indicators" (job vacancies, quit rates, unemployment rates, and continuously improving supply) have shown clear signs of balance, he stated that the unemployment rate is still at a "historical low," with monthly job gains of 218,000 in April and May still "strong," and wage growth remains above the level consistent with 2% price inflation.

In addition to wage growth, Powell also mentioned other factors that could make price inflation more sticky. He stated that the rise in import prices could transmit to consumer price inflation. Furthermore, Powell pointed out that housing services inflation may take some time to return to a more normal level, and the rental inflation in the May CPI report was disappointing.

What scenarios could prompt the Fed to cut rates before the election? Deutsche Bank believes that this would require similarly moderate inflation data in the coming months, as well as a simultaneous slowdown in economic growth and labor market data:

The most important timing for rate cuts is when the Fed gains enough confidence that the inflation rate is on a sustainable path to 2%. Powell explained that the median core PCE forecast for 2024 is 2.8%, meaning that inflation is "not bad, but not great" for the remainder of this year.

While Powell did not emphasize hawkish signals from the dot plot, he also did not specifically indicate a high likelihood of rate cuts before the election. Although the outlook for this outcome has improved with the softening of CPI data in May, the signals from the June FOMC meeting indicate that for a rate cut in September, continuously declining inflation data, cooling economic growth and labor market, and tightening financial conditions must all be in place