ANALYSIS – Slowing US inflation raises September rate cut likelihood

– Probability of a Fed rate cut in September has jumped from below 50% to over 91%   

– Chair Jerome Powell says the Fed is seeing ‘more good’ data and does not necessarily need to wait until inflation hits 2% target to lower rates 

– Investors are more confident of an imminent rate cut, boosting US stock exchanges Nasdaq and S&P 500 to new highs 

ISTANBUL

Declining consumer inflation in the US has increased the likelihood of a first interest rate cut by the Federal Reserve in its September meeting.

The consumer price index (CPI), which measures changes in prices of commonly purchased goods and services, annually rose 3% in June, lower than market estimates of a 3.1% gain, while slowing down from May’s 3.3% year-on-year increase, according to Labor Department figures released last week.

On a monthly basis, the CPI declined 0.1%, bucking market expectations of a 0.1% increase and showing a slowdown from May, when there was no change.

The monthly dip is a first since May 2020, while the annual gain of 3% is a significant decline from the year-on-year increase of 9.1% in the summer of 2022.

To fight record inflation, which reached its highest level in over four decades just two years ago, the Fed has undertaken unprecedented monetary tightening, raising interest rates by a total of 525 basis points over the course of 11 meetings from March 2022 to July 2023.

Although consumer prices had been slowing down, the Fed skipped interest rate hikes four times in the second half of last year, and another four time this year.

The US central bank last made a rate hike of 25 basis points on July 26 last year.

Powell’s hint and probability data

While many analysts believed the Fed would begin cutting interest rates sometime in the first half of this year, members of the Federal Open Market Committee (FOMC) adopted a wait-and-see approach.

Up until last month, Fed Chair Jerome Powell’s position was that economic trends were positive, but there was a need for “more good data.”

He told a Senate committee the FOMC does not believe it would be appropriate to start cuts until it has “gained greater confidence” that inflation is moving toward the 2% target.

However, after last week’s figures, Powell said the Fed is now seeing “more good” inflation data, paving the way for its first interest rate cut later this year.

“Lately we have been getting some of that,” he said in response to a question at The Economic Club of Washington DC on Monday.

He also said the FOMC does not need to wait until inflation hits its 2% long-term target to begin lowering interest rates, citing the lagging effect of monetary tightening.

“If you wait until inflation gets all the way down to 2%, you have probably waited too long, because the tightening that you’re doing is still having effects which will probably drive inflation below 2%,” he explained.

Following Powell’s comments, the probability of a rate cut of 25 basis points at the Fed’s Sept. 18 meeting spiked to 91.4%, according to the FedWatch Tool provided by the Chicago Mercantile Exchange Group.

Last Thursday, after the inflation figures were released, the rate cut probability had jumped to 84.6%, shooting up from below 50%.

It spiked further to 88.1% on Friday, despite producer prices coming in hotter than market expectations.

Producer inflation in the US annually rose 2.6% in June, the largest year-on-year advance since March 2023, official figures showed, higher than market estimates of a 2.3% gain.

On a monthly basis, the producer price index (PPI) was up 0.2% in June, also above market expectation of a 0.1% increase.

For the next Fed meeting, which will conclude on July 31, there is a 93.3% probability that the central bank will keep its benchmark interest rate unchanged in the 5.25% to 5.5% target range, which is the highest in 23 years.

– Positive reaction from markets

Investors’ rising confidence in a September rate cut has boosted US stock exchanges.

The Nasdaq and the S&P 500 hit new highs Thursday, after they rallied for seven consecutive trading days.

The S&P 500 climbed to an all-time high of 5,642.45 points during the session on Thursday, while the Nasdaq reached a new record of 18,671.07 points.

The Dow Jones industrial average closed above 40,000 for the first time on Friday. The blue-chip index, which includes 30 prominent American companies, climbed to an all-time high of 40,257.24 during the day.

The index increased 1.6% last week, posting gains in the last three consecutive trading days.​​​​​​​