There is a massive amount of US data coming out this week, with the most proximal events that could shake up the markets being US GDP and the FOMC rate decision. There is near-unanimous agreement in the market and among economists that the Fed will hold rates unchanged on Wednesday.
Where there is considerable uncertainty is what happens after that. The market is pricing in only around a 60% chance of a rate cut at the September meeting. Typically, the Fed likes to give some warning before moving rates. So, that could be foreshadowed in the policy statement, or more likely, in Fed Chair Jerome Powell’s post-rate decision press conference. However, there is the Jackson Hole Symposium between now and the September rate decision. That does mean it’s possible to still have a cut at the following meeting, but not drop any hints of it just yet.
A Three-Way Split?
The Fed is under increasing pressure to lower rates, as is well-known by US President Donald Trump’s “colourful” tweets about the Fed Chair. But some of that pressure is internal, with some FOMC members arguing that tariff-induced inflation is transitory and the labour market is showing weakness. They don’t see the point in waiting until September.
The other side argues that the less-than-expected inflation that has been observed so far is just a sign that the full effect hasn’t been felt yet. It takes time for businesses to adjust to new policy, and that means inflation could be reaching a peak later in the year. The Fed has a reputation to preserve, after saying rising consumer prices after covid would be “transitory” and then being behind when raising rates.
Prices Over Growth
Centrists somewhat agree that rates need to come down sooner rather than later. At the current rate, they are restrictive and slowing the economy. But the otherwise resilient US economy, shown by strong positive GDP growth, implies that the Fed can wait a little longer to see how the inflation situation plays out. These appear to be the majority for now.
What could change some minds here is the release of the flash US Q2 GDP reading just hours before the Fed wraps up its policy meeting. The US economy is expected to rebound from a technically negative first quarter to 2.4% annualized growth (-0.5% prior). An unexpectedly poor reading here could convince some of the centrists not to wait another month, and get markets hoping for easing coming sooner. On the other hand, a strong US economy would signal that there is room to keep rates higher, potentially after September.
The Market Reaction
Given the uncertainty about what will happen in September, the market is likely to react regardless of the outcome. The issue will likely resolve around how clear a signal for the next meeting is.
If the focus remains on inflation, then the market is likely to interpret that as a sign that the FOMC is willing to keep waiting. But if there is more talk about the jobs market or worries about economic growth, this could signal more easing is coming.