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Will the Fed Wait too Long to Ease?

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US financial markets are in a bit of disarray at the moment, as there seems to be data pointing in opposite directions. While this uncertainty could be good for the dollar in general, there does seem to be a decided risk-on attitude that could undermine the greenback. At least until some of the ambiguity around the Fed rate is resolved.

There are a series of Fed speakers this week, and the markets are keen to parse their comments into getting some clarity over what happened last week. That’s when there was that unusual situation of CPI coming out almost on top of the Fed rate decision. And the results were largely contradictory.

On a Collision Course

Inflation numbers for May were particularly good, with the headline figure growing at the slowest pace since mid-2022. That’s pretty much where the spike in inflation started (back then, US Treasury Secretary Janet Yellen was talking about “transitory” inflation, and the Fed was saying that 3% for a short while was acceptable). So, it seems that the consumer price battle is near to being won.

Then a few hours later the Fed released its dot-plot matrix, showing that FOMC members believe there will be only one rate cut this year. Presumably that’s the one the markets are pricing in for September, which is in the third quarter. This is an important change from the prior dot-plot matrix at the end of the first quarter, in which the consensus among FOMC members was for three rate cuts.

Gathering Storm Clouds

Earlier this week, retail sales data came in weaker than expected for the second month in a row. That tracks with inflation coming down, since it means that consumers are less willing to spend. Lower demand translates into lower prices as a general rule.

The problem is that the US is a consumer-driven economy, so if consumer demand falters, so could the economy as a whole. The rise in unemployment suggests that employers are not as confident in the outlook for their products and services as well. The Fed acknowledges that its interest rates are in “restrictive” territory, meaning that they are a drag on the economy. So, if the economy tips over and under-performs, the Fed could end up getting the blame.

Keeping to the Schedule

The Fed also doesn’t like making sudden moves unless they are really necessary. And this could pose a timing problem. Generally, the FOMC will try to give a heads-up to the market one meeting in advance. It didn’t do that in June, but it could in July.

The thing is, after July, there is a skip through August before the September meeting. The consensus is that the Fed has penciled in that month already for moving towards easing, and it might not want to be seen being pressured by recent data. But that’s three months away in which the Fed doesn’t have an opportunity to move the calendar up, anyway. If it warns a rate cut is coming in July, that will still happen in September, anyway. At this point, it would likely take something extraordinary to get easing going sooner than is already set – but it would be really easy to wait another month if the data isn’t there yet. That leaves the bias to the upside for the dollar, even if it has momentary downward excursions.

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