The Federal Reserve stopped just shy of telegraphing a September pivot to rate cuts on Wednesday, but the S&P 500 rallied strongly as Chairman Jerome Powell said it would take a reversal of recent disinflation progress to keep rates this high for longer.
Fed Chair Powell
"A reduction in our policy rate could be on the table as soon as September," Powell said in his postmeeting news conference, as long as inflation comes in line with expectations. Inflation readings for July and August will be due before the Fed's next policy update on Sept. 18.
With the Fed's primary inflation rate, the PCE price index, down to 2.5% and core inflation at 2.6%, "We can afford to dial back" the restrictiveness of policy, Powell said. He noted that the recent easing in services inflation is especially encouraging.
Powell also continued to highlight the risk of waiting too long to ease policy, which would lead to an unwanted softening of the labor market.
As it is, Powell said, the labor market has largely normalized. He said he doesn't want to see significant "further cooling" of the labor market, but that the Fed will respond more forcefully if it happens.
A higher unemployment rate could be one signal that the labor market is softening more than desired, Powell said. The Labor Department's July jobs report is due Friday at 8:30 a.m. ET.
Economists expect the July jobs report to show that the economy added 180,000 jobs last month, including 155,000 in the private sector, while the unemployment rate held at 4.1%.
How Fast Will The Fed Cut?
The timing of the pivot to rate cuts wasn't really in question going into today's Fed meeting, with markets pricing in 100% odds of a quarter-point rate cut by the Sept. 18 Fed meeting.
The Fed has exercised patience in waiting for the right time to pivot, with a full year having now elapsed since the final hike of the cycle last July. It's reasonable to expect a deliberate pace of rate-cutting as long as inflation is still working its way back to 2%. Nomura economists are forecasting one quarter-point rate cut per quarter, unless the labor market takes a turn for the worse.
That suggests some risk that markets are going a bit too far in pricing in rate cuts. After the Fed meeting, markets were pricing in 75% odds of 75 basis points in rate cuts before the end of the year, the equivalent of three quarter-point cuts. Odds of three cuts rose from about 65% earlier on Wednesday.
Stocks Soar On AI, Rate-Cut Optimism; Meta Jumps Late
S&P 500
After the Fed policy pronouncements, the S&P 500 closed up 1.5%, holding strong gains amid a raft of tech earnings reports, but finishing off the day's highs hit during Powell's talk. The S&P 500 closed 2.75% below its July 16 all-time closing high.
At the close of the Fed's June 12 meeting, Powell had hinted that easy financial conditions argued for waiting on rate cuts: "When we do start to loosen policy, that will show up in a significant loosening in financial market conditions," Powell said. "It's a consequential decision for the economy and you want to get it right."
While the S&P 500 rally is still intact, it has had a bit of a different feel than it did heading into the prior Fed meeting on June 11-12. Through Tuesday, the S&P 500 had managed just a 0.3% gain since June 12, while AI chip leader Nvidia had fallen 26% from its intraday peak on June 20.
With investors paying more attention to doubts raised about just how transformational AI will be, the Fed can set aside worries about the potential for a dot-com-like bubble, at least for now. Back when the Fed cut rates in 1998, the S&P 500 surged 25% in the next six months. That no longer looks like a given.
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