Goldman Sachs Suggests Fed Rate Cut in July Amid Rising Confidence

Goldman Sachs Suggests Fed Rate Cut in July Amid Rising Confidence 

After Powell predictably avoided giving any clues about the timing of the Federal Reserve's next move, he did note that the last three inflation reports had "added to confidence."

Speculation is now focused on when, not if, action will be taken.

Goldman Sachs chief economist Jan Hatzius pointed out this morning that the Federal Open Market Committee (FOMC) has a strong, though unspoken, motivation to avoid initiating cuts in the last two months of a presidential election campaign. This doesn't rule out a cut in September, but it makes a July cut more attractive.

Hatzius began by highlighting that the modest 0.06% rise in the US core CPI for June suggests the Q1 increase was an anomaly, partly due to lingering seasonal effects.

Considering CPI and PPI data, while awaiting import prices, Goldman Sachs estimates monthly inflation rates of 0.19% for core PCE and 0.15% for core market-based PCE. The Dallas Fed trimmed-mean PCE likely rose 0.15% in June, returning to late last year's lows on a 3-month annualized basis.

Further benign inflation figures are expected in July and August, partly due to ongoing weakness in shelter costs, which will be particularly evident in July's report due to the way shelter inflation is averaged over six months and January's high reading.

Source: Federal Reserve Bank of Dallas, Haver Analytics, Goldman Sachs Global Investment Research

To understand the US labor market's health, we must navigate through conflicting and sometimes distorted data. The key takeaway is clear: while layoffs remain low, the unemployment rate is gradually rising because job creation isn't keeping pace with the number of new labor force entrants.

Fed officials have welcomed the slight rise in unemployment so far, but we concur with Chair Powell's view that the labor market is now balanced.

We might soon reach a turning point where further weakening in labor demand could lead to a significant and less favorable rise in unemployment.

The recent mix of weaker employment surveys and slightly below-trend GDP growth—averaging about 1.6% in the first half of the year—warrants attention.

Source: Haver Analytics, Goldman Sachs Global Investment Research

Using the latest unemployment and inflation data, we estimate that the median Fed staff's monetary policy rules suggest a funds rate of 4%, much lower than the current rate of 5¼-5½%.

Source: Federal Reserve Board, Haver Analytics, Goldman Sachs Global Investment Research

Considering this, along with the positive June CPI report and Chair Powell's recent congressional testimony, we anticipate that rate cuts will begin soon.

Markets are nearly fully priced for a rate cut at the September 17-18 FOMC meeting, which we consider our baseline forecast. However, there is a compelling case for an earlier cut at the July 30-31 meeting.

First, if the justification for a cut is clear, delaying it by seven weeks seems unnecessary.

Second, monthly inflation rates are volatile, and a temporary rise could complicate a September cut. An earlier cut in July would avoid this risk.

Third, the FOMC aims to avoid rate cuts during the final two months of a presidential campaign, even though this is never officially acknowledged.

This preference doesn't eliminate the possibility of a September cut but suggests that a July cut would be more prudent.

Currently, the market remains skeptical...

...and naturally, Powell emphasized the Fed's independence:

"We don't put a political filter on our decisions."

Finally, Jan Hatzius is not alone in considering a July rate cut...