Traders raise the chances of a Fed rate cut following inflation report

Even with inflation running well above the Fed’s target, markets on Wednesday became more convinced the central bank will cut rates by September.

Annual inflation, as measured by the consumer price index, fell to 4.9% in April, the lowest in two years but still more than double the Fed’s 2% target.

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Still, that was enough for traders to raise the odds of a rate cut in September to nearly 80%, according to CME Group. Fed Watch Tracker The price of the fed funds futures market. In fact, the policy rate implied by the October fed funds contract is 4.84%, almost a full quarter point lower than the current effective rate of 5.08%.

Among Wall Street analysts and economists, though, the case for a rate cut remains flimsy.

“The timing of the first rate cut will depend on how quickly inflation slows and how quickly the job market becomes less tight,” said Bill Adams, chief economist at Comerica Bank. Weak employment conditions and further declines in inflation “will allow the Fed to start cutting rates as early as this fall.”

However, the bar for rate cuts appears high, even if the central bank decides to hold off on raising rates for now.

New York Fed President John Williams, an influential policymaker and voter on the rate-setting Federal Open Market Committee, said on Tuesday that he does not expect policy to ease this year, even though he believes There are other possibilities besides this.

“In my forecast, we need to maintain a restrictive policy stance for quite some time to ensure that we actually bring inflation down,” he said during an appearance at the Economic Club of New York. “In my baseline forecast, I don’t see any case for a rate cut this year.”

Still, markets are pricing in multiple rate cuts in 2023, totaling 0.75 percentage points, which would bring the Fed’s benchmark rate down to its target range of 4.25%-4.5%. The central bank last week raised the federal funds rate by 25 basis points to 5.0%-5.25%, the 10th increase since March 2022.

Even if they choose not to raise rates, policymakers are likely to continue to discount expectations of more accommodative policy in the coming months.

“What they’re really fighting against is the expectation in the market that they’re going to ease. But they’re not pushing the notion that peak rates are going to be higher,” said Paul McCulley, a former managing director at Pimco and now Conon. Nail University senior fellow in financial macroeconomics, said Wednesday on CNBC’s “Squawk on the Street.”

“They’re going to sound pretty hawkish until they get a lot of clear data that we’re really where we want to be,” said McCully, using market terminology for a preference for higher rates. and tighter monetary policy.

this April CPI report It provided mixed signals on the direction of inflation, with the core reading (excluding food and energy costs) holding fairly steady at 5.5% per annum.

In addition, a Atlanta Fed’s “sticky CPI” indicator, A measure of little volatility in prices, it was just under 6.5% in April. The price-elastic CPI, which measures volatile items such as food and energy costs, rose 0.3 percentage points to 1.9%.

“The annualized pace of core inflation remains well above the Fed’s 2% target and shows no signs of a downward trend,” PNC senior economist Kurt Rankin wrote in response to the CPI data. That fact is crucial.” “A rate cut on this front is necessary before the Fed’s monetary policy rhetoric is expected to change.”

Ahead of the CPI release, the market had been pricing in a roughly 20% chance of a rate hike at the June 13-14 FOMC meeting. After the meeting, that probability dropped to 8.5%.

Andrew Hunter, deputy chief economist at Capital Economics, wrote that this came despite a “temporary pause in the previous downward trend” in inflation.

“We don’t think this will convince the Fed to raise rates again at the June FOMC meeting, but it does suggest that there is a risk that rates will remain elevated for a little longer than we assume,” Hunt said.