Has the market gotten too excited again? The Fed's resistance to inflation is not all sunshine and rainbows

On Tuesday, the U.S. producer price index (PPI) growth rate for July was lower than expected, further easing market participants' concerns about inflation and strengthening traders' expectations that the Federal Reserve will cut interest rates multiple times before mid-2025. According to the Federal Reserve observation tool from the Chicago Mercantile Exchange, traders generally believe that the Fed may cut interest rates by a full 200 basis points before July next year, which would bring the Fed's main interest rate target down from the current 5.25%-5.5% range to around 3.25%-3.5%. At the same time, they expect a 50 basis point rate cut with a 54.5% probability at the Fed's next meeting on September 18, with further easing expected before the end of the year. In other words, traders have returned to their multiple rate cut views held at the beginning of the year, but this time based on concerns about economic slowdown or recession, which seem to outweigh concerns about inflation. The issue is that so many rate cuts would mean that policymakers believe they will not trigger inflation again. However, last weekend, Fed Governor Bowman expressed caution about rate cuts, pointing out that she still sees risks of inflation rising. The Tuesday report showed a slight 0.1% increase in July PPI on a month-on-month basis, but economists like Stephen Stanley warned that the data includes quirky and unstable factors. Paul Ashworth stated that the report "is not as good as it looks." Lauren Henderson, an economist at Stifel, Nicolaus & Co., said that the details of the report are "not balanced enough." Despite some signs of anti-inflation trends in the PPI report, Henderson said she and her company are still waiting for more data. Henderson said over the phone, "Unlike the market, our basic expectation is that the Fed will stand pat in September until we see Wednesday's Consumer Price Index (CPI) data and end-of-month Personal Consumption Expenditures (PCE) data." She said, "We are more inclined to Bowman's view, believing that the risks are skewed to the upside and currently do not expect the first rate cut in the fourth quarter." The CPI report for July, to be released on Wednesday, is expected to show that inflation will remain at 3% year-on-year, with core inflation slightly below 3.2% annually. Following this, the annual Jackson Hole Symposium, a Federal Reserve favorite, will take place from next Thursday to next Saturday, giving Powell an opportunity to express whether his thoughts have changed before more data emerges. The Fed's preferred inflation gauge—July PCE data—is scheduled for release on August 30, followed by the August CPI report on September 11, a week before the widely expected first rate cut by the Fed. "Considering that first-quarter inflation data has been higher than expected for three consecutive months, we are a bit tired of the market's high rate cut expectations," Henderson said. "The Fed does not have a good track record of achieving a soft landing, and has only done so once in the mid-1990s According to past cycles, the Federal Reserve will find it difficult to achieve the delicate balance of lowering inflation and maintaining economic stability. However, this cycle is very different from past cycles. Stifel Nicolaus does not rule out the possibility of the Federal Reserve winning the anti-inflation battle while cutting interest rates. The CPI report on Wednesday and the August inflation data released in September will determine many things, and traders are confident that the Federal Reserve will begin easing policy next month. Their only question is whether the rate cut will be the usual 25 basis points or larger. Derek Tang, an economist at the Washington Monetary Policy Analysis Company, said the current issue is, "Do you believe that inflation will decrease anyway? If so, then cutting interest rates to avoid the risk of recession will not have a cost, because in the case of stagnant inflation, the Federal Reserve can still slow down the pace of rate cuts, which is not so bad. The real problem is if the Federal Reserve's mistake in cutting rates leads to inflation rising again. That would be a problem because slowing down the rate cuts is not enough to solve it." He said that cutting interest rates seems to be the price that Federal Reserve officials are willing to pay now, "if it means there is a chance to save economic expansion and prevent the economy from falling into recession." "Nevertheless, there may be more supply shocks, whether from the United States or abroad. This means that the inflation outlook will be more turbulent, and Federal Reserve officials will need to ask themselves whether they can really achieve the 2% target, or whether they should allow some variation around this level." As demonstrated in the first half of the year, even without actual action by the Federal Reserve, expectations of rate cuts may have an impact: the stock market's rise in May was seen as a contribution to the so-called wealth effect, making many Americans feel wealthier, which may lead to more questioning of how consumption demand could decrease enough to lower inflation. Despite receiving many positive news in the fight against inflation, the Federal Reserve still cautiously states that it will not cut rates too quickly in the coming months and says it needs more confidence in the data before taking action. Glenmede, based in Philadelphia, manages $45.5 billion in assets. Michael Reynolds, Vice President of Investment Strategy at the company, said, "We believe the Federal Reserve is very concerned about the risk of cutting rates too quickly." Reynolds said, "The Federal Reserve will wait for a reason until the September meeting. Before that, it will receive two CPI inflation data. If there are signs of improvement in inflation, policymakers will have room to start cutting rates." He said, "We believe that the Federal Reserve slowly and systematically returning interest rates to a neutral level is a sustainable path. Our fundamental view is that the economy will not fall into recession, but we must closely monitor labor market data, as the situation may change rapidly."