The Federal Reserve is widely expected to keep interest rates at a 23-year high for a seventh straight time this week and signal fewer rate cuts this year than previously expected.

Investors and other market watchers will be closely watching the latest economic projections from Fed officials, as well as the dot plot. Economists generally expect the Fed to cut interest rates once or twice this year, rather than the three times it forecast in March. The Fed's forecast for inflation will also be an important clue to the timing of the first rate cut.

The slowdown in inflation stalled in the first three months of the year, dashing Wall Street hopes that the Federal Reserve could cut interest rates aggressively in 2024, but economic data subsequently showed inflation slowing again in April and May. Fed policymakers need to be convinced that inflation has cooled enough and expect it to slow further before cutting rates.

Powell's remarks at the post-meeting press conference may also provide some hints on expectations for subsequent rate cuts. The Fed chairman is likely to double down on officials' current strategy of patiently waiting for more data to prove that inflation is moving toward the 2% target before starting to cut rates. The solid job market reflected in the latest employment data is helping the Fed stay on hold.

Meanwhile, the Fed's delay in cutting interest rates contrasts with other central banks, such as the European Central Bank and the Bank of Canada, which have already begun to reduce borrowing costs.

Clues to the first rate cut

Based on pricing in the futures market, Wall Street currently believes that the best time for the Federal Reserve to cut interest rates for the first time is September.

Before that meeting, Powell is expected to give a speech at the Jackson Hole symposium in August, which typically contains key hints about policy moves later this year. Fed officials generally appear to agree that interest rates are high enough and the Fed can keep them steady for now because of the economy’s resilience.

“The policies we have in place are working,” New York Fed President John Williams said a few weeks ago when asked at an event hosted by the Economic Club of New York whether he would support a rate cut. “But views about the appropriate path of policy are adjusting as the outlook changes.”

Still, Powell and other officials have reiterated in recent speeches that the Fed is likely to cut rates sometime this year, a view he may reiterate in his post-meeting news conference. Minneapolis Fed President Neel Kashkari said at an event in late May that "there will certainly be no more than two rate cuts."

Whenever the Fed starts cutting rates, it will be a difficult and important decision because there are risks if the Fed cuts rates too soon, which could lead to a pickup in inflation, and there are risks if it cuts rates too late, which could lead to a recession because interest rates have been too high for too long.

Ahead of economic slowdown but no alarm bells

The U.S. economy remains healthy by several key indicators, but data show many Americans are under pressure. Interest rates are at their highest level in nearly a quarter century, inflation remains high, borrowers continue to increase debt, and savings accumulated during the pandemic are dwindling. Consumer spending has also slowed in recent months, and retailers say consumers have changed their purchasing behavior.

In addition, Fed officials’ unemployment forecasts for this year are likely to be revised upward, as the current 4% unemployment rate is already in line with officials’ current median forecast for 2024. Weaker-than-expected April payrolls totals raised concerns that the economy is deteriorating rapidly, but months of weaker data suggest the month was likely a one-off and does not reflect a new trend.

“We’re seeing nominal levels cool off from levels that are still elevated, so we’re basically just returning to a more sustainable level of growth,” said Garrett Melson, portfolio strategist at Natixis Investment Managers.

Still, economists generally expect the overall economy and job market to slow further in the second half of the year. A cooling economy is a boon for lowering interest rates.

Will inflation continue to slow?

The Fed is clearly not happy with where inflation is at right now, and it remains to be seen whether officials will soon be satisfied with progress. The Fed’s official target is 2%, so it will stick with keeping rates high until inflation reaches that threshold and lasts for several months.

PCE, the Fed's preferred inflation measure, rose 2.7% year-on-year in April, sharply lower than the 4.4% expected in April 2023. But on an annualized basis, consumer prices rose 2.9% in the six months to April, accelerating from 2.4% in the previous six months. Powell has said "we are not satisfied with 3% inflation."

The latest data on Wednesday showed that the U.S. CPI rose 3.3% in May from a year earlier, unchanged from the previous month, indicating that price pressures have eased. The core CPI rose 3.4% year-on-year, lower than the expected 3.5%. Adam Sarhan, CEO of 50 Park Investments, said that the market was worried that inflation would be stronger than expected, just as last Friday's employment report was stronger than expected. The fact is that it was not stronger than expected and was lower than expected, which made the market feel relieved.

The fact that CPI came in lower than expected is a catalyst for the market to expect another move higher. This also gives the Fed a lot of room to start cutting interest rates in the foreseeable future.

The article is forwarded from: Jinshi Data