Investors are confident that the Federal Reserve will cut interest rates by the end of its September meeting.
As of Tuesday morning, markets were pricing in a 100% chance of an interest rate cut in September, according to the CME FedWatch Tool, up from a 70% chance a month ago.
The boost in confidence comes after a better-than-expected inflation reading in June combined with signs of further cooling in the labor market. In sum, economists and investors have taken the data to mean the Fed will start cutting interest rates as soon as inflation falls near the Fed’s 2% target.
“Recent data has shown a continued softening in the labor market and significant cooling of inflationary pressures, most notably in the all-important housing category,” Deutsche Bank’s chief U.S. economist Matthew Luzzetti wrote in a research note. July 12, which included a projection for a September. rate reduction. “These developments should materially affect the outlook for monetary policy.”
Fed Chairman Jerome Powell said on Monday that the latest data had added “somewhat” to the central bank’s confidence that inflation is falling within its target. However, the Fed chairman declined to specify what exactly that means for the Fed’s tapering timeline.
“I’m not going to send signals about any particular meeting,” he said. “We will make these decisions meeting by meeting and the evolving data and the balance of risks.” Powell said during an interview at the Economic Club of Washington.
Given the recent string of improving inflation data, while the labor market has shown signs of slowing, some on Wall Street have called for the Fed to start cutting interest rates before their impact on the U.S. economy drives the market of work in a chaos.
In a new research note on Monday, Goldman Sachs chief economist Jan Hatzius argued that there is “a strong case” for the Fed to begin tapering at its next meeting on July 31.
“First, if the case for a cut is clear, why wait another seven weeks before submitting it,” Hatzius wrote. “Secondly, monthly inflation is volatile and there is always the risk of a temporary re-acceleration, which could make the September cut difficult to explain. A July start would obviate that risk.”
Hatzius also noted that while the Fed has pledged its independence from the upcoming election, the cut in July would avoid further speculation about a political motive behind its policy decisions. As of Tuesday morning, two weeks until the start of the Fed’s next meeting, investors are pricing in just a 7% chance of a July cut, according to the CME FedWatch Tool.
Whether July is a possibility or not, investors now feel confident that the path forward for interest rates is lower. Belief that the cuts will come soon has fueled more breadth in the stock market rally.
The market’s favorite areas of the past year have underperformed as investors rotate into non-tech sectors.
The Roundhill Magnificent Seven ETF, which tracks the group of big tech stocks that led the stock market’s rise in 2023, has fallen more than 3% in the past five days. Meanwhile, Real Estate ( XLRE ) and Industrials ( XLI ), both interest rate-sensitive sectors, have been the market’s biggest gainers over the same time period, rising around 5%.
The small-cap Russell 2000 Index ( RUT ) is up more than 10% and finally surpassed its 2022 high for the first time during the current bull market.
“If this trade continues, if the prospect of a rate cut is still in play for this fall, then we may finally see the bull wake up and that’s good news for all investors,” he told Yahoo! Ritholtz Wealth Management chief market officer Callie Cox. Finances on Monday.
Josh Schafer is a reporter for Yahoo Finance. Follow him to X @_joshschafer.
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