FED: What's it going to take to lower rates

We’re still waiting for clarity, and it’s going to be a while. There wasn’t much news to report out of the May FOMC round, other than there wasn’t much news to report out of the May FOMC round. The Fed held rates steady between 4.25% and 4.50%, and Powell spent most of his press conference either explaining that policymakers could end up doing just about anything or batting away questions about Congress or the administration and monetary policy.

This shouldn’t come as a shock if you’ve been reading our research. So, instead of digging into the specifics of what was said or what was meant, the short answer is not much and nothing; we’re going to dive into the latest data and what it would take for policymakers to start lowering rates. As we’ve discussed in previous notes, even the best macro data is backward-looking and misleading in real-time. And we don’t have reliable forward-looking indicators, which means that the Fed will likely be in a holding pattern for a while, unless the boat really starts taking on water.

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Cooling inflation is probably a head fake. While the March data was encouraging, there were signs that it’s still far too early to pop the champagne. As the chart below shows, the revisions in the prior two months, January and February, were sizeable. So much so that even with the five-year low in the monthly rate, the three-month moving average was essentially unchanged from February at 0.29%. In other words, it’s still unclear if the March core PCE numbers were the start of a new trend or a pre-tariff mirage.

Perhaps the most troubling part of the March inflation data was that it came out before the April 2^nd announcement of “reciprocal” tariffs. The January and February inflation readings look very much like a runup in prices before the implementation of additional tariffs. In that context, a March lull makes sense. However, that cooling is likely to be met with at least a moderate uptick in inflation in the coming months as companies begin to pass along the trade war costs to consumers. The good news is that the recent de-escalation on Chinese tariffs and the concepts of a trade deal with the UK suggest we’ll avoid what could have been a historical surge in inflation. The bad news: 30% levies on Chinese imports are still significant and disruptive, we don’t yet know what any of the trade deals will look like, they could be reversed, and the inflationary impact of previous hostilities still hasn’t landed on U.S. soil. The big meteor didn’t strike, but we still may get hit by a barrage of smaller asteroids.

The recent trade news means less risk to employment. The labor market was resilient in April. Employment grew by 177k (220k after adjusting for weather), and the unemployment rate flat-lined at 4.2%. Job gains remain somewhat concentrated, although less so than last year, and the number of people working part-time but would like full-time work and those not in the labor force who want a job held firm at prior levels. It wasn’t a perfect report, but it was hard to find much to worry about.

The trade war didn’t affect April's data meaningfully because the Bureau of Labor Statistics (BLS) survey took place the same week that “reciprocal” tariffs were implemented. The BLS survey always occurs in the week of the 12th of the month, which in April, was a Saturday. That meant that the survey was released on April 7^th and concluded on April 11, not even enough time for the market to fully grapple with the tariff impact, let alone Main Street. And as we discussed in our March Labor Market Watch, employment data can be revised significantly in real-time, making it hard to separate the signal from the noise until well after impact.

The bar is still high for the Fed to cut rates. Even if the trade war effects are less severe and more temporary than was expected a month ago, recent events will still lift prices for many goods. With inflation still above target and trade policy uncertainty persisting, albeit at a lower level, policymakers will be cautious about reducing rates when job growth is strong. As Powell said, they won’t be rushed.

Ironically, the trade war de-escalation may end up making a June cut less likely if the inflation data rebounds as we expect, as the probability of a recession in 2025 is now much lower - a change that’s reflected in our May economic and financial market forecast suite. Policymakers are still likely to lean into the employment data when assessing the non-inflationary economic impact from the remaining set of tariffs.

Given the historical real-time chop in employment data, we believe policymakers will wait for proof that the monthly pace of inflation has cooled at levels near 0.165%, or for the labor market to contract by more than 100k jobs in consecutive months, before deciding to resume rate cuts in 2025.

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