The Fed says the U.S. economy is ‘back on a disinflationary path’

Fed Chairman Jerome Powell thinks the U.S. economy is on the cusp of beating inflation but cautioned that more evidence is needed for rate cuts.

Speaking at a European Central Bank conference in Portugal, Powell said the latest U.S. inflation data “do suggest that we’re getting back on a disinflationary path.”

“We’re getting a gradually cooling economy, a gradually cooling labor market, progress on inflation, 4% unemployment, 2% growth. We’re getting kind of what we want to have,” Powell explained.

Nevertheless, the Fed needs “more data like what we’ve been seeing recently” before it can lower interest rates.

Powell’s muted optimism follows promising data suggesting that the Fed’s battle against rising costs has reached a turning point.

In May, the core Personal Consumption Expenditures (PCE) index—the central bank’s preferred measure of inflation—posted its smallest monthly increase in three and a half years. On an annual basis, core PCE rose by 2.6%, which isn’t that far from the Fed’s 2% target.

Meanwhile, a lesser-known inflation metric that tracks producer prices posted a surprise drop in May, suggesting that wholesale costs are also beginning to moderate.

Taken together, the latest inflation reports have many economists penciling in more than one rate cut this year.

Rate-cut optimism grows (again)

Although Fed officials expect only one rate cut in 2024, a “strong majority” of economists polled by Reuters say the central bank will reduce rates twice this year, beginning in September.

Wells Fargo’s senior economist Sam Bullard agrees, saying it’s likely that the disinflation process will continue in the coming months. Meanwhile, Citigroup economists said they expect three rate cuts this year.

Wall Street futures markets imply a strong possibility that there will be two rate cuts before the end of 2024.

According to CME Group’s Fed Watch Tool, the most likely target for the federal funds rate is 4.75% to 5% by December. That implies two 25 basis-point reductions.

In addition to inflation data, Wall Street is closely monitoring monthly employment figures. Akira Takei, a fixed-income manager at Asset Management One, thinks the “Fed will pivot fast once the jobs market shows a rapid deterioration.”

While that hasn’t happened yet, the labor market has clearly cooled in recent months.

“They’re watching a slowdown, and at some point, you’re going to want to stop the slowdown from slowing further,” said Jonathan Pingle, chief U.S. economist at UBS, referring to the Fed’s preference to cut rates before the labor market and economy deteriorate further.