Farmers Credit: The Federal Reserve could cut interest rates in July, but it won't do so

Farmers Credit Bank expects that the Federal Reserve will stand pat at the July FOMC meeting, with the federal funds rate target range remaining at 5.25-5.50%. This is in line with market pricing, as the market believes there is only about a 5% chance of a rate cut. This would mean that after the most recent rate hike by the Federal Reserve in July 2023, rates will remain unchanged for eight consecutive meetings.

However, the bank believes that with further improvement in inflation data in recent months and increasingly clear signs of cooling in the labor market, the Federal Reserve is not far from cutting rates. The bank's baseline forecast suggests that the first rate cut will come at the next meeting in September.

Inflation has been a major focus for the Federal Reserve in recent years. The upside surprises in the first quarter of 2024 have completely reversed in the past few months. The inflation data for May and June have been particularly encouraging. After three consecutive months of 0.4% month-on-month increases in core CPI from January to March, it dropped to 0.3% in April, 0.2% in May, and 0.1% in June. This has brought the three-month annualized level down from 4.5% in March to 2.1%. Moreover, the inflation deceleration in May and June has been broad-based, including in the super-core services sector excluding housing.

The downward trend in inflation is also reflected in the Federal Reserve's preferred core PCE inflation data, which rose by only 0.1% in May and 0.2% in June. Chairman Powell has acknowledged the progress on inflation but has stated that more data is needed to build confidence.

Additionally, the labor market is increasingly becoming a focus for the Federal Reserve.

The minutes of the June FOMC meeting indicate that the Federal Reserve had extensive discussions on the labor market. FOMC participants explicitly stated that the risks to the dual mandate are becoming balanced, with further cooling in the labor market potentially leading to an increase in the unemployment rate rather than a decrease in job vacancies. The Beveridge curve may be transitioning from steep to flat.

Even without considering the Beveridge curve, other data also indicate that signs of cooling in the U.S. labor market are becoming more apparent. For example, while overall nonfarm payrolls remain strong, they are starting to cool off. Combining recent data with revisions to previous data, the three-month moving average is now at its lowest level since January 2021. Additionally, the quit rate is below pre-pandemic levels, and household survey employment data is quite soft. Household survey employment has only increased by 237,000 over the past 14 months, leading to a 0.7 percentage point increase in the unemployment rate from its cyclical low to 4.1% in June.

Taking all these factors into account, Powell acknowledged during his semiannual monetary policy testimony that "high inflation is not the only risk we face" and noted that recent employment reports provide a "clear signal" of a "significant cooling in the labor market - something I wouldn't say before the most recent data." This indicates that as the labor market weakens, the employment aspect of the dual mandate becomes more important Farmers Credit Bank pointed out that, considering the performance of the dual mandate, the bank even believes that a rate cut in July is reasonable, but the Federal Reserve will not do so because it is extremely unwilling to bring surprises to the market. Unless the upcoming data has significant surprises, September will be the next possible timing.

Therefore, the focus of the July FOMC meeting will be on forward guidance, and market participants will closely watch whether the Federal Reserve is paving the way for future rate cuts. The bank believes that the Federal Reserve will provide relevant signals, but in a more subtle manner, as the FOMC aims to avoid explicitly committing to any specific time frame. Due to being misled by data in the past, the Federal Reserve will tend to act cautiously and refrain from issuing signals with specific time frames in advance.

This may mean that the forward guidance in the policy statement may remain unchanged, continuing to indicate that "in determining the