June 2024
The Federal Reserve was adamant about reversing their series of rate hikes last December, only to be forced to back-track when economic growth reignited in the first quarter. When growth reaccelerated, there were even calls, albeit muted, that the Fed would need to raise interest rates at least one more time. Through the second quarter, the talk of another rate hike has been quelled by a resumption in the fall of inflation and a cooling in the job market.
The June jobs report was a mixed bag in terms of economic growth. The economy added 190,000 new jobs in the month, and while that was below the consensus forecast of 206,000, it still suggests that the economy continues to grow at trend. However, beneath the surface are details that indicate the jobs market may not be as healthy as the headline suggests. For starters, the previous two months’ total was revised 111,000 lower, taking some of the froth out of last month’s outsized gain. Looking to the change in household employment, the gain last month was 116,000, bringing the three-month change to -267,000, while the change in the labor force over the same period was an increase of 114,000. Even more disturbing, the unemployment rate registered 4.1%, the highest since touching 3.4% in January 2023. Not to say that the employment picture presents a situation where the economy is poised to suddenly slip into recession. But there does seem to be a trend developing and some forecasters are expecting the unemployment rate will tick up to 4.5% by the fourth quarter. That would represent a risk to continued economic growth.
The consumer price index offered some good news to the market, coming in at a 3.0% year-over-year rate, and falling -0.1% versus the previous month’s index. Recall that bond investors became nervous when the year-over-year index ticked up to 3.5% in March. The most recent CPI jibes with the University of Michigan 1-year inflation expectations of 2.9%.
The combination of the weakening jobs market and improving inflation was enough for Fed Chairman Powell to strike a dovish tone at the most recent testimony before Congress. In describing the dual mandate of stable jobs and low inflation he said inflation has shown “modest further progress” and that labor markets have cooled “considerably.” We interpret that as meaning that a rate cut has once again been moved to the front burner of the FOMC’s agenda.
Anticipating rate cuts, the Fed Funds futures market has once again priced in an aggressive rate cutting cycle. As of the morning of the CPI release, the June 2025 Fed Fund future is forecasting 125 basis points of rate cuts. With the current overnight rate at 5.32% and the year-over-year inflation at 3.0%, cutting the overnight rate to 4.0% would imply a real rate of return of 1.00% even if CPI doesn’t make any further progress toward 2.0%. Given the Chairman’s comments, we expect that the first cut will be delivered at the September meeting and the Fed members will be watching the economic data for any further softening.
