With inflation low, market expects a rate-cut signal from the Fed

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A slowing economy and below-expectation inflation may force the Federal Reserve to cut rates this year.

The Federal Open Market Committee has stated it will be patient in regard to interest rates, and its Summary of Economic Projections suggested rates would remain at a range of 2.25 to 2.50% this year. But when the panel meets June 18-19, the post-meeting statement could speak of a rate cut and the new SEP will be watched closely.

Futures markets are already pricing in two rate cuts this year.

“Odds of a cut at next week’s Fed meeting are low, but Chairman Powell is likely to signal openness to rate reductions at coming meetings,” said Bill Merz, director of fixed income at U.S. Bank Wealth Management. Various members of the Fed have made comments in recent days implying lower policy rates are on the table,” he wrote in a commentary.

On Wednesday, the consumer price index was below expectations, suggesting the markets may be right in predicting rate cuts this year. The Labor Department reported CPI and the core rate each rose 0.1% in May. Economists polled by IFR Markets expected a 0.1% rise in the headline number but a 0.2% climb in the core rate, which excludes volatile food and energy numbers.

The year-over-year rises were 1.8% and 2.0% at the core, each 0.1-point less than expected and each down a similar amount from April.

Energy prices fell 0.6% in the month, with gas declining 0.5%, following a 5.7% spike in April. Food prices grew 0.3% in May, following a 0.1% dip in the prior month.

“Financial conditions have moved sharply easier in recent days, largely driven by market pricing for Fed easing,” according to an analysis from Morgan Stanley Research. “That's important because conditions could tighten significantly if market expectations for Fed policy were to reverse materially in the absence of any changes to the growth outlook.”

S&P Global Ratings altered its forecast that the Fed would hold the benchmark rate steady this year and raise it in 2020. “Increasing headwinds for the world's largest economy will likely push the Federal Reserve to lower interest rates this year, after three years of slow but steady monetary-policy tightening,” S&P said in a release. “But the winds have shifted, with the Trump administration fighting trade battles on more than one front, which we think could disrupt global supply chains and weigh on business and consumer confidence.”

S&P projects one rate cut, as early as September, and depending on data, “the Fed will then likely remain on the sidelines, with last year's run of four rate hikes having marked the end of the tightening cycle.”

While tariffs may result in an uptick in prices that shows up in future reads of CPI, S&P said, “The Fed would likely see any increase in inflation caused by tariffs as temporary.” Even so, core inflation is unlikely to breach its 2% target. “The slowdown in economic momentum faster than what the Fed anticipated is also likely going to weigh on inflation expectations, and in turn, the Fed's decision to cut rates.”

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