Fed holds rates in July, but almost confirms September rate cut

2 Aug 2024 , 09:23 AM

FED HOLDS RATES AT 5.25%-5.50% IN JULY MEET

It was called the worst kept secret that, the Fed would not cut rates in July. Even the CME Fedwatch has hinted at a certain rate cut in September but unlikely rate cut in the FOMC meeting on the last day of July. There were sections of the market that savoured an outside hope of a pre-emptive rate cut in July itself. There were reasons for that view. The US CPI inflation for June 2024 had fallen sharply by 30 bps to 3.0% while for the month of June, the PCE inflation (based on personal consumption expenditure) had also fallen by 10 bps to 2.5%. Markets were wondering; if that was not a confirmation of falling inflation, then what is? However, the Fed has been playing it safe, and considering the robust GDP numbers, it can afford to play safe. After all, contrary to market apprehensions, the hard landing has been avoided. The first advance estimate of Q2-2024 GDP growth has doubled sequentially from 1.4% to 2.8%. So, action shifts to September.

JEROME POWELL WARNS AGAINST TOO MUCH OPTIMISM IN 2024

In his post policy statement, Jerome Powell almost hinted that this may be the last policy statement in which the rates were held flat. In sync with the expectations of the CME Fedwatch, Jerome Powell also confirmed that one rate in September was on the cards. However, looking ahead, Powell has cautioned against too much optimism about the second rate cut also happening in 2024. In fact, prior to the policy statement, the CME Fedwatch had assigned a probability of more than 95% that the second rate cut would happen in December 2024. Powell underlined that while one rate cut was on the cards, two rate cuts in 2024 would be too optimistic. Instead, the Fed may prefer to back-end the rate cuts and be more aggressive in 2025, armed with more data points. Clearly, Powell does not want a situation when the Fed goes aggressive on rate cuts and subsequently has to adopt course correction. The macro consequences of such a move would be quite prohibitive.

KEY SIGNALS FROM THE JULY 2024 FED STATEMENT

The tone of the Fed statement in July also continued to be very cautious. However, Powell himself admitted that there were elaborate discussion on the timing and quantum of rate cut going ahead. The first rate cut looks quite likely in September 2024, although future rate cuts would be entirely data dependent. Here are some of the signals we gathered from the Fed Statement on July 31, 2024.

• In an important shift, the Fed officials clearly hinted that inflation was getting closer to its 2% target. This is the closest one can actually expect the Fed to get when it comes to giving signals of a September rate cut. However, the Fed members also added a cautionary covenant that more progress was needed for rate reductions can happen.
• The statement that warmed the cockles of the market was that the, “The risks to achieving its employment and inflation goals continue to move into better balance.” This is normally the closest that the Fed would get to hinting at a rate cut. Market analysts assess that this statement ranks as a slight upgrade from the previous language.
• In his post Fed Meet interaction, Fed chair, Jerome Powell underlined that there was no decision made about actions at future meetings. The condition was that economic data must show inflation easing. Powell pointed out that if that test was met, a reduction in policy rates could be on the table as early as the upcoming September meeting.
• In terms of the language, the Fed statement was an upgrade on two counts. Firstly, it used to the word “adequate progress” against “modest progress” last time to taming inflation. Secondly, in the previous statement, the inflation was characterized as being elevated, while in the July meeting it is classified as just somewhat elevated.
• The Fed specifically pointed in its statement that rate was at the highest level in the last 23 years. Also, after 11 consecutive rate increases, the Fed had kept rates on status quo for the last one year. The hint was that the Fed had been adequately attentive to risks and the time was now ripe to take up the first affirmative action on cutting rates.
• One more cautionary sentence in the Fed statement was, “The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably towards 2%.” However, this is more to underscore that Fed will be depending only on data and not on forecasts.
• Fed’s preferred barometer, PCE inflation, stands at 2.5% in its latest June reading, but other gauges like the CPI inflation are about 50 bps higher at 3.0%. However, Fed has underlined that it will be price stability and employment balance that will determine the future trajectory of rates and not the GDP growth. In short, the Fed means that it will stick with that goal despite pressure from businesses to tolerate higher levels. Fed can afford to do that since GDP has continued to expand, despite elevated rates of interest.
• There are certainly some positive and supportive trends visible in the labour data. The unemployment rate has gone up sharply from 3.5% to 4.1%, but more importantly, the latest report shows wages increasing at their slowest pace in 3 years. However, the larger concerns of persistently high rates stem not just from GDP, but from the high cost of funds that businesses are forced to pay.

To sum it up, September rate cut looks highly probable now. However, the markets must also be prepared for the fact that the Fed officials will proceed carefully, despite signs that inflation is weakening. The Fed would have to be fully convinced that the time is ripe. We could still see the first rate cut in September, but beyond that, the trajectory is unclear.

CME FEDWATCH STILL CONVINCED OF 2 RATE CUTS IN 2024

One way to look at the Fed outlook from a market perspective is to evaluate the CME Fedwatch. The CME Fedwatch captures the probabilities of rate moves at each upcoming Fed meet, based on the implied probabilities of Fed Futures trading. We have considered available data up to September 2025 Fed meeting. The million dollar question is whether so much optimism in the CME Fedwatch is justified? We will get the answers soon.

Fed Meet	275-300	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525
Sep-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	12.5%	87.5%
Nov-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	8.9%	66.1%	25.0%
Dec-24	Nil	Nil	Nil	Nil	Nil	0.1%	10.0%	64.6%	25.3%	Nil
Jan-25	Nil	Nil	Nil	Nil	0.1%	8.0%%	53.5%	33.3%	5.1%	Nil
Mar-25	Nil	Nil	Nil	0.2%	8.1%	48.9%	35.0%	7.5%	0.4%	Nil
Apr-25	Nil	Nil	0.1%	5.3%	34.7%	39.8%	17.1%	2.9%	0.1%	Nil
Jun-25	Nil	0.1%	3.9%	26.7%	38.4%	23.2%	6.7%	0.9%	Nil	Nil
Jul-25	Nil	1.9%	14.7%	32.2%	31.3%	15.4%	4.0%	0.5%	Nil	Nil
Sep-25	1.6%	12.8%	29.7%	31.4%	17.7%	5.6%	1.0%	0.1%	Nil	Nil

Data source: CME Fedwatch

The CME Fedwatch has been broken up into 3 milestones; December 2024, April 2025, and September 2025. The probabilities of rate cuts and the eventual rates at each of these milestone has been evaluated. Here are our quick inferences.

• While the CME Fedwatch has assigned 100% probability to the first rate cut in September 2024, it is also assigning a probability of 12.5% to a 50 bps rate cut in September. CME Fedwatch has assigned a high 75% probability that the second rate cut of 25 bps may happen in November itself. As of December 2024, there is a 100% probability of 50 bps rate cut and a 75% probability of 3 rate cuts. That is much more aggressive than anything the Fed has hinted at in its statement.
• What is the situation as of April 2025. The CME Fedwatch is assigning a 97% probability that there would be 100 bps of rate cuts by April 2025, while it is assigning a probability of 80% to 125 bps of rate cuts by April. There is a much lower probability of 40% for rate cuts of 150 bps by April 2025, so that looks quite unlikely at this juncture.
• Let us turn to the final milestone of September 2025, to check out the CME Fedwatch expectations at that point. There is a high probability of 93% that there would be 150 bps of rate cuts by September 2025, taking the Fed rates to the range of 3.75%-4.00%. Ther is also a 76% probability that by September 2025 there would be rate cuts to the tune of 175 bps. However, the 2025 probabilities are likely to evolve in a more granular fashion depending on how the Fed reacts to data in the current calendar year.

For now, the CME Fedwatch tends to be very optimistic that the Fed would be aggressive in rate cuts. However, that is now really borne out by the statements made by Fed. In the past, it is usually the Fed officials who had the last word and the CME Fedwatch had to adjust its probabilities to the Fed view. It remains to be seen how it plays out this time around.

FED THEME – RATE CUTS WILL BE DICTATED BY FED INTERPRETATION OF DATA

For now, let us just forget about the different expectations indicated by the Fed and the CME Fedwatch. The CME Fedwatch certainly appears to be a lot more aggressive than what the language of the Fed has been indicating. However, the theme is that the decisions will be based on the macro data flows and, more importantly, by how the Fed interprets these data flows. Here is what we read from the Fed statement on July 31, 2024.

• The Fed Chair Jerome Powell best captured the sense of the moment with his statement, “a reduction in our policy rate could be on the table as soon as the next meeting in September.” However, Powell also hastened to add that this purely in the realm of expectations and the Federal Open Market Committee was yet to decide.
• Interestingly, Powell has pointed out that the decision to cut rates or otherwise in September 2024 would be entirely an apolitical one. That means, the US presidential elections in November and the likely candidates will not have any bearing on the decision. This puts to rest concerns that investors may have about political overtones.
• An interesting point made in the Fed statement was that, “while the Fed had embarked on rate hikes as early as March 2022, the full impact of that restrictive policy trickled into the broader economy in full force only in the last 6 months. This is evident from the fact that the unemployment rate has edged up and consumer spending in interest rate sensitive areas is tapering.
• Powell has reiterated time and again that Fed members were conscious of the risks of starting rate cuts too soon and the risk of going too late. The former could trigger inflation and the latter could escalate the cost of fund and have a spiralling effect on the economy. The FOMC is getting the sense that the US economy was getting closer to the point; appropriate to begin to dial back restriction. That gives hopes of September cut.
• Jerome Powell has explicitly made a point that the committee may be open to lowering rates in September, and that the reduction in policy rate could be on the table as soon as the next meeting in September. This is the first time that a dovish commitment has been given by the Fed chair, although the hawks still have a lot of clout in the FOMC. At least, the risks to achieving employment and inflation goals are moving into much better balance as compared to the previous meetings.

However, the bottom line is that the macro data points between now and mid-September will still carry a lot of weight in the final Fed decision to cut rates in September 2024.

HOW WILL RBI INTERPRET JULY 2024 FED STATEMENT

RBI implemented its last rate hike in February 2023 and kept status quo since. In recent months, the RBI was waiting for the election outcome and the presentation of the full budget. Now, all that is done. However, food inflation is still too high and the RBI may not be too keen to cut rates till food inflation is effectively tamed. The above average rainfall in July is likely to help tame food prices. RBI is unlikely to touch rates in the August meet and may prefer to wait for the Fed action in September. The crescendo for a rate cut is building up in India too, and the RBI may have to oblige sooner, rather than later!