Note to readers: Coverage of the Fed policy announcement and Fed Chair Jerome Powell's news conference is at this link:
Today's Federal Reserve policy statement will likely indicate increasing confidence that inflation is on track to return to target, setting the stage for an initial rate cut at the Sept. 18 Fed meeting. Everything has lined up for the Fed pivot, with the disinflation trend resuming, the labor market in balance and the AI-led S&P 500 rally cooling enough to ease worry about a 1999-style melt up.
ADP Employment Report, ECI
The monthly jobs reported from payroll processor ADP showed 122,000 additional private-sector jobs in July, trailing estimates of 154,000. Job growth was the slowest since January.
The Employment Cost Index, the Fed's primary gauge of wage inflation, showed compensation costs rose 0.9% in the second quarter, below 1% estimates. That lowered the 12-month increase in the ECI to 4.1% from 4.2%.
Among private employers, 12-month compensation gains slowed to 3.9% from 4.1%.
Fed Chair Powell
While Powell won't commit to easing in September, it's a good bet that he'll call it a "live meeting," meaning a rate cut will be on the table.
In recent appearances, Powell's tone has turned more dovish. "We are getting back on a disinflationary path," Powell said in early July, even before tame June consumer price index data confirmed the trend.
Powell told Congress on July 12 that the labor market "appears to be fully back in balance," meaning the supply of available workers roughly matches hiring demand. As a result, the labor market is "not a source of broad inflationary pressures for the economy now."
Job Market Holds Key To Outlook
The Fed's primary inflation gauge, the core PCE price index, didn't obviously advance the disinflationary story, with last week's release showing the 12-month core inflation rate holding at 2.6%, above 2.5% forecasts. That followed stronger-than-expected 2.8% GDP growth in Q2, suggesting the economy isn't at risk of rolling over.
Yet the recent data only amounted to a pause in the disinflation story, not a reversal. Meanwhile, the June jobs report was probably as soft as the Fed wants to see. After sharp downward revisions to earlier data, the average private-sector job gain averaged 145,666 per month in Q2, which is the slowest pace since the massive job loss at the start of the pandemic.
Meanwhile, average hourly earnings growth has slowed to 3.9% and the jobless rate has climbed to 4.1%, the weakest level for both data points since 2021.
Powell has made the commitment that the Fed won't wait too long to ease, which could lead to unneeded labor market weakness. Now there's nothing stopping him from making good on his word.
How Fast Will The Fed Cut?
The timing of the pivot is no longer in question, only the pace, 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. As of Wednesday morning, markets are pricing in 67% odds of 75 basis points in rate cuts before the end of the year.
While today's Fed meeting may not substantially shift the Fed rate-cut outlook, Friday's jobs report might, if it looks like the ADP report.
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%.
S&P 500
S&P 500 futures rose 1.3% early Wednesday amid a raft of tech earnings reports. However, the S&P 500 closed off 0.5% on Tuesday, leaving it 4.1% below its record high on July 16. The Nasdaq, though bouncing today, has fallen 8% since its July 10 peak.
While the S&P 500 rally is still intact, it has a different feel than it did heading into the prior Fed meeting on June 11-12. Through Tuesday, the S&P 500 has since managed just a 0.3% gain, while AI chip leader Nvidia has 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.
Be sure to read IBD's The Big Picture column after each trading day to get the latest on the prevailing stock market trend and what it means for your trading decisions.
