Fed Rate Cut Expectations Shift Amid Key U.S. Data Releases
This week has been important in shaping expectations regarding the Federal Reserve's (Fed) policy path, led by U.S. data. Market participants were nearly evenly split between expecting a 50 basis point or a 25 basis point rate cut by the Fed in September. The data released this week has shifted the needle towards expectations of a 25 basis point rate cut.
On Wednesday, the Consumer Price Index (CPI) data showed that inflation in the U.S. increased by 0.2% compared to the previous month, which was in line with expectations. However, the headline figures increased by 2.9% year-over-year, falling short of the 3% rise expectations. This increase marked the lowest annual inflation rise since March 2021.
Besides, core inflation, which excludes food and energy prices, rose by 0.2% month over month and by 3.2% year over year.
The inflation report published by the U.S. Bureau of Labor Statistics indicated that 90% of the monthly increase in headline inflation was driven by a 0.4% rise in the shelter index. Other contributing factors include motor vehicle insurance, household furnishings, education, recreation, and personal care expenditures.
The steeper-than-expected annual decline in headline inflation supported expectations that the Fed will cut rates this year. However, the persistence in shelter costs and the continued strength in personal consumption expenditures reduced rate cut expectations in terms of basis points.
On the other hand, yesterday's Initial Jobless Claims and Retail Sales reports supported the reduction in rate cut expectations. For the week ending August 9, jobless claims were reported at 227K, below the 235K expectation.
The four-week moving average of claims, which smooths out weekly fluctuations, fell to 236K. This data helped ease some concerns about an excessive cooling in the U.S. labor market.
Additionally, U.S. retail sales in July increased by 1% compared to the previous month. Markets had expected a 0.3% increase following the previous month's 0.2% decline.
Retail sales are considered a significant measure of U.S. household consumption. Therefore, the stronger-than-expected rise in sales indicated that U.S. household spending remains robust, suggesting that inflation risks persist.
However, with pandemic-era savings largely depleted and wage growth starting to slow, U.S. households are increasingly relying on debt instruments like credit cards to sustain their expenditures. A report released by the New York Fed earlier this week revealed that default expectations among U.S. consumers have risen. This raises doubt about the sustainability of consumer spending and supports expectations that demand-driven inflation in the U.S. will continue to decline.
According to the FedWatch tool, before this week’s data, a 50 basis point rate cut in September was priced at 55%, while a 25 basis point rate cut was priced at 45%. However, both the CPI and labor market data have increased expectations that the Fed may opt for a less aggressive rate cut path than previously anticipated, shifting the focus towards a 25 basis point cut. Market participants are now pricing in a 70.5% probability of a 25 basis point rate cut. According to Bloomberg data, the total expected rate cut for 2024 has decreased to 92 basis points.
Treasury Yields Hit Monthly Highs; Precious Metals Show Resilience
With expectations of aggressive rate cuts being shelved, U.S. 2-year Treasury yields have risen to their highest levels since the beginning of the month, reaching 4.10%. Benchmark 10-year yields, meanwhile, remained around 3.92%.
Although precious metals initially declined due to rising yields, they largely recovered their losses. Rate cuts expected from the Fed are still priced at a significant level of 92 basis points, and ongoing geopolitical risks continue to support safe-haven metals like GOLD.
Looking Ahead: Fed Chair Powell's Speech
Market participants will be looking forward to Fed Chair Jerome Powell's speech at the annual central bank symposium next week. Following this speech, markets will turn their attention to the critical labor data expected at the beginning of the next month.