After Wednesday’s tame inflation report, experts agree that the Federal Reserve will cut interest rates at its next meeting in September.
Consumer prices rose 2.9% in the 12 months through July, the smallest increase in three years and down from 3% in June.
So, inflation is gradually moving toward the Fed’s target of 2%. Its favored inflation indicator, the personal consumption expenditures price index, is even closer to the target. It stood at 2.5% in June.
That’s on top of the July employment report, which showed slowing job growth and an upward tick in the unemployment rate.
Given the Fed’s dual focus on inflation and jobs, those numbers explain the universal agreement that the central bank will lower rates in September.
The only question is whether it will go 25 basis points or 50 points.
Interest-rate futures show a 62.5% chance that the Fed opts for 25 points and a 37.5% chance that it chooses 50 points, according to CME FedWatch.
The case for 25 points; your own investing
For what it’s worth, my own opinion, formed from 40 years of writing about the Fed, is that it will trim by 25 basis points.
Related: CPI inflation report upsets betting on big Federal Reserve rate cut
First, employment isn’t collapsing, and neither is inflation. Payrolls rose 114,000 in July. They may have been depressed by Hurricane Beryl, though the government didn’t see any impact.
In any case, payroll numbers have bounced around a lot this year. So they could rebound a bit in the coming months. The unemployment rate, 4.3%, is rising but remains below historical levels.
And inflation, as mentioned above, is still higher than the Fed’s target. So, there are plenty of economic reasons to go only 25 basis points.
In addition, the Fed usually eases by 50 points only in cases of emergencies, like the financial crisis of 2008 and the Covid-19 pandemic in 2020.
Going 50 points now might indicate the Fed is panicking in the face of an economic and financial situation that’s not nearly as dire as some think.
As for the impact of lower rates on you, it might be a good time to consider bond funds if you’re looking to put some money to work in fixed-income.
Related: With Fed set to cut rates, this money move may pay off
Bond funds gain in value when rates fall. So, you get capital appreciation in addition to your interest payments. I’ve started buying Vanguard Total Bond Market Index Fund ETF (BND) .
Its total return was 7.95% for the last 12 months, quite attractive for a relatively safe fund.
Mark Zandi offers sharp criticism of Fed
Getting back to the Fed, esteemed economist Mark Zandi of Moody’s Analytics thinks the central bank should have begun cutting rates months ago because of the employment and inflation data.
Also arguing for rate cuts are volatility in financial markets and the pressure that high interest rates are putting on the financial system, he told Yahoo.
Rising rates have troubled both large and small banks. “5.5% is quite high,” Zandi said, referring to the Fed’s 5.25%-5.5% target for the federal funds rate.
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That rate is what banks charge each other for overnight loans. Banks need those loans to keep their daily capital levels stable.
Zandi thinks the Fed should slash rates by 50 basis points next month but believes 25 points is more likely. “The Fed will likely try for 25 points each quarter going forward,” he said. “I would argue for much faster than that.”
Looking at the economy, Zandi sees the probability of recession at one-third next year. That’s about twice the probability for any given year, as recessions occur about once every seven years.
Related: Veteran fund manager sees world of pain coming for stocks
