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US June SPI: Make or Break the Rate Cut

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Today could see the release of the most important data of the week, if not the whole month. After Fed Chair Jerome Powell’s testimony before Congress yesterday and the day before, markets are primed to get confirmation on interest rate easing. But there is some risk of disappointment that could jolt markets after a series of data pointing in one direction.

Powell’s two-day testimony before Congress did stick largely to the script. But, as anticipated, a tweak in his commentary got the attention of markets. The head of the Federal Reserve addressed the latest jobs numbers, suggesting they show the labor market has “cooled considerably”. That’s exactly what traders who are eager for a rate cut want to hear.

The Last Obstacle Out of the Way

The Fed has a dual mandate to maintain full employment as well as ensure price stability, but it has been facing the opposite problem, recently. In fact, this persistently tight labor market has led to inflationary pressure. Too low unemployment means workers can demand wage increases that are higher than productivity increases, which implies that inflation will increase.

With the unemployment rate going over 4.0%, Chair Jerome Powell said that the jobs numbers and the inflation rate were coming into balance. If the jobs market loosens too much, then the Fed has to look at easing in order to support employment. If the Fed is satisfied with the direction of the labor markets, then it implies that the last obstacle towards cutting has largely been cleared away.

A Dovish Tilt, But What About the Data?

The comments on the labor market while sticking to the script on inflation left the markets with the impression that Powell’s speech had a dovish bent. More dovish than recent comments from other FOMC officials who either did not talk about labor markets, or were still concerned. That tempered the reaction a bit, since in the end it’s a vote of the whole FOMC that determines monetary policy, not just the dovishness of the Chairman.

But, Chair Jerome Powell as leader of the institution, presumably has his finger on the pulse of his colleagues. And it’s important to point out that even though his comment was dovish, it fit neatly into a context of very strong, repeated and determined remarks about the need for more data to finally get around to bringing out the interest rate trimming shears. Which means there is even more weight attached to the data coming out this afternoon.

What to Watch Out For

US headline CPI is expected to continue its descent to 3.1% from 3.3% prior, bringing it almost back to where it was in late winter and the markets were cheering the prospect of 6 rate cuts. It would also be the third consecutive drop in inflation, which could solidify the notion that a downward trend has reasserted itself.

But the Fed cares more about the core rate, which strips out more volatile elements such as energy and food. And there the situation is more complicated, because June US Core annual CPI change is expected to be unchanged at 3.4%. So, a mere single decimal of a beat would reverse a downward trend that has lasted for more than a year. Markets might be able to dismiss it as a one-off in the context of all the other data pointing to softer prices. But it illustrates how a relatively small change can have a big impact on the market’s reaction.

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