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The Fed’s Future, Part 2: Market Anticipations Amid Economic Slowdown

Wall Street had already been leaning toward a bet that the Federal Reserve would begin to cut interest rates in September. The numbers released last Friday, July 5th, firmed up those expectations, with two quarter-point cuts now fully priced in this year. Investors are poised for a report to show a slowdown in the pace of hiring in June, building on weak services and manufacturing data, and firming up their expectations of interest rate cuts starting as soon as September.

Market Reactions

Signs of lower rates in the near future, which would make it cheaper for consumers and companies to borrow, have typically been accompanied by market rallies. Stock indexes tracking larger companies have been buoyed in recent weeks. The S&P 500 has repeatedly set fresh records and is up more than 16 percent this year. However, the Russell 2000 index, which tracks smaller companies that are more sensitive to the ebb and flow of the economy, has largely flatlined, with weaker economic data nudging the index 0.5 percent lower ahead of the Independence Day holiday.

Economic Forecasts

Economists had forecasted that the June jobs report would show a healthy labor market, albeit with fewer jobs added and an easing in wage growth. Earlier in the week, widely watched surveys of manufacturing and services activity both came in lower than expected. Coupled with signs of cooling inflation, a deceleration in economic growth would give the Federal Reserve a justification for cutting rates, which have been held at high levels for months.

Fed’s Future Actions

Jerome H. Powell, the Fed chair, stated at a conference last week that if economic data continued to come in as it has recently, the Fed could consider cutting interest rates. “We’ve made quite a bit of progress in bringing inflation back down to our target, while the labor market has remained strong and growth has continued,” Mr. Powell said. “We want that process to continue.” Although Mr. Powell did not specify when the Fed would start to cut rates, investors are forecasting action in September, with roughly two quarter-point cuts expected for the year. Those bets have increased from the start of the week, when a cut in September was seen as more of a 50/50 proposition. The data has come in “a bit weaker than expected,” noted analysts at Deutsche Bank, “and it all added to the theme that the economy was losing momentum as we arrive in the second half of the year.”