Investors Expect the Fed to Cut Rates in September

Photo Credit: Brandon McDonald, Unsplash

Weekly Market Recap for June 21st

This week, stocks and bonds traded range-bound. The large size factor continued to outperform Small, and there was limited factor and sector dispersion. Treasury yields were volatile but ultimately ended the week unchanged, with bonds remaining overbought territory after the recent drop in yields. Notably, WTI crude traded back above $80 per barrel.

S&P 500 Index (Last 12 Months)

S&P 500 Technical Composite (Last 24 Months)

May Jobs Report

Two labor market surveys provided conflicting data in May. The establishment survey, which provides industry-specific details, showed that jobs grew by +272,000, compared to the estimated 180,000. Healthcare (+68,000), Government (+43,000), and Leisure and Hospitality (+42,000) accounted for approximately half of the job gains as they were rehired after the pandemic. March and April job gains were revised lower by a combined -15,000.

In contrast, the household survey, which provides demographic details, showed that jobs decreased by -408,000 in May. The decline caused unemployment to rise +0.1% to 4%, matching the highest since November 2021. Although unemployment is still very low by historical standards, the trajectory remains upward. Unemployment continues to rise since troughing at 3.4% in early 2023. However, the details matter. Nearly all the lost jobs in the household survey were in the 20-24 age group. The 25-54 age group saw the number of employed grow by +87,000, while the 55 and over group fell by -31,000.

Investors Expect a September Cut

The graph below shows the likelihood of a 5.25% Fed funds rate at the September 2024 FOMC meeting. In other words, it's the probability of 1 cut by September. At the start of 2024, investors placed a 100% probability of a cut by September, with the forecast calling for multiple cuts by September. The probability drifted lower in Q1 as inflation progress stalled and plunged in April after the strong March jobs report and hot CPI. The likelihood of a cut by September dipped below 50% by late April and recently returned there at the end of May. However, it has risen sharply this month after negative economic surprises, including a weak ISM Mfg PMI, a rise to 4% unemployment, and soft retail sales.

The probability currently sits at 67%, among the highest since early April. This is the most convinced investors have been for a cut since early Q2. Whether the Fed cuts in September depends on inflation, the labor market, and other hard data in the coming months. If the market is overestimating the extent of the slowdown, yields are likely to reverse higher.

Investors Becoming More Confident in September Cut

May Housing Data

This week, the Fed held interest rates steady. The main update was the Summary of Economic Projections (SEP), which forecasts higher inflation this year, fewer rate cuts, and a higher terminal rate (Figure 5). The continued upward revisions to Core PCE and the 2025 and Longer Run fed funds rates caught our attention. Since December, the 2024 Core PCE estimate has been raised from 2.40% to 2.80%. Over the same period, the estimated 2025 fed funds rate was revised from 3.60% to 4.10%, while the terminal rate was raised from 2.50% to 2.80%. These rising inflation and fed funds rate estimates are the Fed’s way of acknowledging persistent inflation. One notable statement by Chair Powell during the press conference was, “If you’re at 2.6%, 2.7% PCE inflation, that’s a good place”. The result is a higher projected terminal rate, although there is little consensus on how to get there. The median forecast for the December 2025 fed funds rate is 4.10%, but the 2.9% to 5.4% range is wide. Given the potential for inflation noise and the Fed’s desire to avoid being seen as influencing the election, we don’t expect the first cut until late Q4.

Building Permits and Housing Starts Fall to 4-Year Lows

Homebuilder Confidence Falls to New 2024 Low

Look Ahead to Next Week

The calendar is quiet next week before activity picks up the following week with PMIs, job openings, and payrolls (Figure 15). This week's economic releases included:

Retail Sales
Actual: +0.1%
Consensus: +0.3%
Prior: -0.2%
Commentary: This is a soft report, with April and March revised lower. Falling gas prices contributed to the slowdown, with retail sales +0.3% when gasoline is excluded. This indicates that spending is cooling after strong readings earlier in 2024.

Industrial Production
Actual: +0.9%
Consensus: +0.3%
Prior: +0.01%
Commentary: Broad-based increase in manufacturing rose +0.9% after declining in April and March; May's report conflicts with soft survey data, as ISM Mfg PMI fell to 48.7 earlier this month.

Homebuilder Sentiment
Actual: 43
Consensus: 45
Prior: 45
Commentary: Lowest reading since December 2023; weak reading attributed to high mortgage rates and elevated construction costs; builders may soon find relief with Treasury yields and mortgage rates falling since the start of May.

Housing Starts
Actual: 1,277k
Consensus: 1,390k
Prior: 1,352k
Commentary: The lowest since June 2020; a broad slowdown across single-family and multi-family starts; single-family back to 2H 2023 levels, while multi-family only marginally above the pandemic trough.

Building Permits
Actual: 1,368k
Consensus: 1,450k
Prior: 1,440k
Commentary: Lowest since June 2020; permits fell -3.8% from prior month and -9.5% from prior year.

Important Disclosures
This material is provided for general and educational purposes only and is not investment advice. Your investments should correspond to your financial needs, goals, and risk tolerance. Please consult an investment professional before making any investment or financial decisions or purchasing any financial, securities, or investment-related service or product, including any investment product or service described in these materials.

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