Fed’s Next Steps in Focus as Markets Brace for Further Rate Cuts
After the Federal Reserve (Fed) kicked off its policy easing cycle last week with a jumbo rate cut, the primary focus has shifted to the Fed's next moves. Markets are pricing in a 70 basis point cut by the end of the year, but cautious remarks from Fed officials after the decision may cloud these expectations.
The 50-basis-point cut was approved by an 11-1 vote, with Fed Governor Michelle Bowman being the sole dissenter, supporting a 25-basis-point cut. A few days after the decision, Bowman expressed concerns that the half-point cut risked signaling an early victory over inflation.
Bowman expressed concern that solid growth in spending data, which reflects a healthy labor market, could continue to drive price increases. She noted that core personal consumption expenditure (PCE) prices have risen faster than 2.5% year-over-year, remaining above the target rate.
In contrast, Fed Governor Christopher Waller stated that what convinced him to support the half-point cut was not concerns about the labor market but rather positive inflation data. Moreover, Waller noted that he worried inflation might be weaker than he initially thought. Waller estimates the Fed’s preferred inflation measure, the PCE price index, has increased at an annual rate of less than 1.8% over the past three months, signaling below the target rate.
Waller stated he would support potential quarter-point cuts at the November and December meetings but emphasized that they could move faster if labor market data worsens or inflation comes in lower than expected. Conversely, should inflation increase again, they could pause the cuts.
Last month, Fed Chair Jerome Powell, in his Jackson Hole symposium speech, clearly signaled that the Fed's focus had shifted from inflation to labor market risks, and other officials' comments supported this trend. From the latest statements by Bowman and Waller, it appears that concerns about the labor market are not as high as markets might have thought, and the inflation outlook remains the primary factor in guiding policy decisions.
In this context, the PCE price index for August, set to be released this week, could influence expectations. According to economists surveyed by Bloomberg, the inflation gauge increased by 2.3% year-over-year. If the data comes in line with expectations, it would mark the smallest annual increase since early 2021. However, core inflation is expected to rise from 2.6% to 2.7%.
As inflation data in the U.S. continues to trend toward the target rate, expectations for faster rate cuts by the Fed are growing. However, with the recent declines primarily driven by lower energy costs, while service prices remain sticky and consumer demand stays strong, it is unclear whether upcoming data will convince the Fed to cut by another half point. This uncertainty has limited the pressure on the U.S. dollar since the decision.
On the other hand, in his post-decision statement, Powell mentioned that he believes the neutral rate is higher than in the pre-pandemic period. Economists estimate this rate to be just below 3%. As long as the U.S. nominal neutral rate remains lower than that of Europe and Asia, declines in the U.S. dollar may remain limited.
Gold Hits Record Highs Amid Fed Easing and Central Bank Policy Shifts
Following the Fed's half-point rate cut, gold prices, which have been hitting consecutive record highs, continue to rise due to the possibility of further jumbo cuts by the Fed and geopolitical tensions.
After the Fed's decision, the yield on the U.S. 2-year Treasury note fell to 3.60%, its lowest level since September 2022, while the 10-year benchmark yield stood at 3.76%.
In addition to market pricing in the likelihood that the Fed will make another half-point cut in one of the two remaining policy meetings this year, the upward pressure on gold prices is not limited to this. Besides Fed, other major central banks around the globe have initiated a policy easing cycle, making gold more attractive. This has led to an increase in inflows into gold ETFs, which had been seeing steady outflows for the past 18 months and is expected to support gold prices further.
Major investment banks' forecasts suggest there is still room for gold prices to rise. Goldman Sachs predicts that gold will reach $2,700 by early next year, while Citigroup estimates that it could surpass the $3,000 barrier by April.
On the other hand, record prices are dampening demand from retail gold consumers; jewelry retailers in China, a significant source of demand, report that sales have dropped by more than 50% compared to the same period last year. Furthermore, the improving market outlook, supported by lower interest rates, could spark short-term preferences for riskier assets such as stocks, potentially limiting gold's momentum in the coming period.
PBoC’s Surprise Rate Cut Fuels Speculation for Further Stimulus
At last week’s monetary policy meeting, the People's Bank of China (PBoC) did not announce any changes. However, due to its previous statement indicating that additional policies were being prepared to stimulate the economy, expectations had been raised that authorities will step up efforts to boost growth.
Today, the PBoC's surprise rate cut and the announcement of a press conference tomorrow have sparked further speculation about more actions. Expectations regarding the outlook for the world's second-largest economy are influencing global sentiment.
As part of the cuts initiated in July, the PBoC reduced its short-term policy rate earlier today. It was announced that the 14-day reverse repo rate was lowered from 1.95% to 1.85%.
Additionally, central bank governor Pan Gongsheng, along with two officials, announced a press conference tomorrow on financial support for economic development. Given a series of disappointing data from China last month and these recent moves by authorities, markets have raised their expectations for further stimulus measures.
Economists emphasize that this 10-basis-point cut alone is not sufficient to halt the declining economic momentum and highlight the need for a larger package. Expected measures include cuts to the reserve requirement ratios, medium-term rates, and mortgage rates.
Markets Await RBA Decision and Key Inflation Report
Markets will be closely watching Australia's Reserve Bank (RBA) policy decision and inflation data this week. Economists expect the RBA to keep its cash rate at the 12-year high of 4.35%.
A few hours after the policy meeting, the monthly inflation (CPI) report is expected to show that price pressures in Australia have eased slightly but remain above the target. According to a Bloomberg survey of economists, the weighted mean CPI is expected to rise by 2.8% in August, following a previous increase of 3.5%.
The housing market situation is a key factor in the RBA's decision to keep interest rates unchanged. Housing costs, including rents, make up about one-fifth of Australia’s consumer basket and are the second-largest driver of inflation after services. Annual rent inflation has surged to 7.3%, raising concerns that any rate cut could further exacerbate the housing market.
RBA Governor Michele Bullock recently stated that monetary policy will remain sufficiently restrictive until inflation sustainably returns to the 2-3% target range, ruling out any rate cuts this year.
However, markets continue to price in potential rate cuts by the RBA later this year as the domestic economy slows and global peers begin their own rate-cutting cycles. In this context, the details of the upcoming inflation report could shape expectations for the RBA’s next policy steps.