Will there be two rate cuts by year-end?

Recent readings on the labor market and inflation have increased the expected number of rate cuts between now and year-end. After the Federal Reserve's interest rate-setting arm, the Federal Open Market Committee (FOMC), met in June, they updated their outlook for economic growth, inflation and interest rates. Now, the Fed expects at most two cuts, which is still down from the three cuts expected earlier this year

Market expectations have been even more variable. In early 2024, market expectations exceeded six rate cuts, but the number began to decline as the economy continued to grow, unemployment stayed low and inflation readings were firmer than expectations. We eventually saw market expectations for rate cuts fall below the outlook from the Fed as Fed Funds futures were only pricing in one rate for much of May and June.

We never thought the idea of six rate cuts made sense. Still, with headline unemployment ticking up to 4.1% in June and the most recent consumer price index (CPI) reading coming in below expectations, the Fed Funds futures market is now moving toward two rate cuts for this year. To accomplish two rate cuts, the Fed will need to use their upcoming July 30-31 meeting to begin setting the table for a September rate cut. They would do this by changing their communications around their confidence on inflation. For instance, they might say that inflation is moving sustainably towards their 2% target as the labor market is rebalancing in a way which would lessen wage pressures.

To be sure, housing costs remain higher than desired and core inflation remains higher than 2%, but waiting until inflation hits 2% might very well mean the Fed is late in adjusting their policy. After all, the chart for this week also shows how quickly things can change. Future economic readings can move us one way or the other, but the preponderance of current data seems to indicate some recalibration of policy will be warranted soon.

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