Breakfast Bites - Fed Preview
Watch the Summary of Economic Projections
Rise and shine everyone.
Tensions are running high in the Middle East, as the US scrambles jets and has talked about getting involved in strikes, if Iran doesn’t agree to “unconditional surrender,” as President Trump put it.
This comes on Fed day, a day when markets are already a little subdued. Today’s Fed decision will be accompanied by the Summary of Economic Projections, and all eyes will be on the Fed Funds Rate number. Here’s the last Summary:
We don’t expect a cut today. There are two cuts priced in at the moment - the current Fed Funds Rate is 4.25% to 4.5%, which is an average of 4.375%. The projection for this year is 3.9%, which equates to 3.75% to 4%, i.e., a 0.5% reduction for the year or two 25-bp cuts. (We doubt there’s another jumbo cut.)
What we also got last time was a reduction in GDP growth, and increases in Unemployment and Inflation data. While the inflation data has been coming in quite benign, we think that the effects of the tariffs are still not showing up in most of the data, given the stocking up in inventory and the pause in many of the tariffs.
This means that we may not see the effects of tariffs for a couple of more months. On the other hand, we see the labor market relatively resilient. Yes, there are signs of slowing job growth, but not enough for them to be alarming just yet.
How many cuts for the year?
Given that tariffs are on pause, inflation is still decelerating, and the labor market is “doing okay”, we think the Fed can afford to postpone cuts until they can determine what needs to be done. I’ve been thinking September may be the next cut, but today’s SEP will tell us a little more about whether the Fed is considering cutting twice this year or not.
How will the inflation cycle play out? - Higher prices or demand destruction?
The other big question will be whether we actually see the inflationary cycle play out, i.e., will the tariffs first have an inflationary effect and then move to a deflationary effect?
We’ve been talking about how tariffs will increase prices, and the likes of Walmart has already talked about that. However, what we’re also seeing in some of the data, for example, yesterday’s Retail Sales, is a reduction in demand.
So there remains the possibility that while these tariffs are on pause, we don’t see much of the price increases and there still some demand and perhaps some stocking up, and then we move directly to the destruction of demand.
This will most certainly lead to lower growth numbers, and it remains to be seen whether that is also a metric that the Fed adjusts in their projections.
If this plays out fairly quickly, the probability of the Fed stepping in becomes very high.
Market Outlook
As always, Fed days are tricky, and many are hedged going into the Fed decision. The first response is usually a false positive, as those hedges are removed. Watching the market once the press conference starts is prudent because it gives us a far better idea of what the Fed is thinking and how the market is reacting to that thinking.
Have a safe trading day out there!
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