RSVP to the Fed's pool party on July 31

The timing of the Fed's first cut is the question in markets. Chill. Fed officials are all over the map on willingness to cut and demand more data. July 31 is the earliest cut.

Credit: Thomas Barwick via Getty Images.

Get your pool floaties ready. Summertime.

It’s hard to escape the Fed now. Every scrap of data on inflation causes an outsized market reaction. Blame the hyper-focus on the Fed’s first cut and the Fed’s hyper-focus on data. In today’s post, I argue that the Fed will likely wait until July 31 to cut.

Three main supporting arguments:

• By July 31, the Fed will have six months of core PCE for 2024.

• No dissents on the first cut, and July is enough time to reach consensus.

• The political calendar is irrelevant for the Fed.

I cover the second two below the paywall and the first one here.

It’s the inflation data, stupid.

Every time Fed officials speak, two themes emerge: more data and no rush. Here’s Chair Powell on 60 Minutes in early February:

Basically, we want to see more good data. It's not that the data aren't good enough. It's that there's really six months of data. We just want to see more good data along those lines. It doesn't need to be better than what we've seen, or even as good. It just needs to be good. And so, we do expect to see that. And that's why almost every single person on the, on the Federal Open Market Committee believes that it will be appropriate for us to reduce interest rates this year.

That was about a week before we got the CPI for January. Given the oddities in the data — all of which seemed to go a bad way — the month might only scrape by as “doesn’t need to be … as good.” Powell had tried to tell markets not to freak out over a month, but what did markets do? Freak out. That week of CPI, retail sales, and PPI swung market bets on the first cut, now resting at June as most likely.

The exact month when the Fed cuts is likely not as consequential as the markets seem to think, but it’s more consequential than the Fed seems to think. The uncertainty around the cut is the problem. It’s causing market volatility, which is bad.

It would be un-Fed-like to tell us how many more months of good data it needs to be confident. But now is an excellent time to be un-Fed-like. Volcker didn’t break the back of inflation by sticking to the playbook of the prior decades. The inflation challenge facing the Powell Fed is nothing like the Volcker Fed faced, but the willingness—the confidence—to be bold would be welcome now. Give us a number; give us a date. More clear guidance, not more Fedspeak, would help a lot.

Don’t get your beach towels out yet. So, what are we left with? The data calendar. By the FOMC vote on July 31, they will have six months of CPI, core PCE, and employment for 2024. Six months is a nice, responsible-sounding number.

Currently, core PCE is 2.8% year-over-year—well below its high of 5.5% in 2022. By this summer, even with some bumps and a slow grind down of shelter inflation, core PCE should be undeniably close to 2%. Six months of good data on top of the six months in 2023 should give the Fed more than enough confidence to start cutting. And even the hawkish commentators should see it, too. Time to RSVP.

Buckle in. As I argued in my recent posts, there are risks with this approach.

The Fed is only looking to past inflation, and that's a problem.

My recent podcast with Bilal Hafeez at Macro Hive covers the Fed and more.

It will take time to build consensus.

The Fed is a consensus-driven institution. Even though the FOMC has twelve voting members (and another seven non-voting participants), dissent on any vote is relatively uncommon. Since 1970, about 40% of the meetings had at least one dissent, but since the pandemic began, only 4 of the 35 meetings (11%) had one.

June 2022—the first 75 basis point increase—is the last dissent in this cycle, when Esther George favored a smaller increase. The first cut this year is viewed as a momentous decision. Given the stakes and the Fed’s history, there is no way that Powell will set up the vote without unanimity.

Dissents are basically unheard of at pivotal votes. Here is then-Governor Dan Tarrullo at the ‘lift off’ vote in December 2015:

I don’t think it’s appropriate policy to raise rates today ….

Despite all of that, I will reluctantly go along with alternative B [to raise rates] today for two reasons. First, there is the institutional reality that there’s enormous significance attached out there to a member of the Board voting against the Chair’s [Janet Yellen’s] position. Perhaps this shouldn’t be this way and we might be better off with the culture of the Bank of England’s Monetary Policy Committee, but reality is what it is. This moment of liftoff after seven years would be a particularly bad time to enter a dissent and thereby risk the Chair’s leadership position at a critical moment in monetary policy, which may face some considerable challenges in the months ahead.

The stakes with the first cut in 2024 are even higher than the lift-off in 2015. One could also argue that winning over skeptics, as Tarullo was then, could be more challenging this time. The reputation of the institution will loom large, and consensus will take time.

Here are the voting members of the FOMC. Keep a close eye on their public remarks.

It’s clear there is currently no rush to cut, and some, like the President of the Atlanta Fed Raphael Bostic, see this summer as an appropriate time to cut:

Federal Reserve Bank of Atlanta President Raphael Bostic reiterated his view that it will probably be appropriate for the US central bank to begin cutting interest rates this summer based on his outlook for inflation …

“The last few inflation readings — one came out today — have shown that this is not going to be an inexorable march that gets you immediately to 2%, but that rather there are going to be some bumps along the way,” Bostic said … The slope of the line is still going down,” he said. “I’m of the view that it will probably be appropriate if things go the way that I expect to see us start to reduce rates in the summertime.”

Back to math: there are five months between now and the July 31 vote. That’s a considerable amount of time and data, but building a consensus will require considerable amounts of both. Even so, consensus could come together sooner if the economy or financial markets fell apart. If inflation gets stuck or re-accelerates in the coming months, rate cuts could get pushed out even further.

It’s data, not partisan politics, that decide the cut.

The July 31 vote is two weeks after the Republican convention and two weeks before the Democratic. Some Fed watchers say that alone disqualifies a cut.

As I argued in my recent Bloomberg Opinion piece, the Fed is political but not partisan. The Fed will not put a thumb on the scale for either Biden or Trump. No one at the Fed wants to be Arthur Burns, and no one wants to endanger the institution.

One of the darkest hours in the central bank’s history came in 1972, when Chair Arthur Burns held rates too low in an effort to boost the economy in support of Richard Nixon’s reelection campaign. The explicit coordination was later confirmed in the Nixon tapes. Worse still, inflation roared back after Nixon’s was reelected.

The Fed acknowledged its mistake and vowed never to repeat. One reason is to preserve its independence from direct political control, which is viewed as key to its dual mandate of seeking stable prices and maximum employment.1 This spirit of independence is why the Fed steers clear of commenting on or trying to influence fiscal policy. At apress conference in June, Powell dodged a question in the topic, saying, “I think trying to get into that with lawmakers would be kind of inappropriate, given our independence and our need to stick to our knitting.”

So, what is the Fed’s best approach? Put its head down, use the data, don’t worry about the institution, and show competence.

By putting a high bar on its confidence that the inflation rate is coming down to its 2% target, the Fed can allow the economic data to drive interest rates, not politics. Even if the Fed waits longer than necessary to cut interest rates, the data suggest inflation will likely slow further without a recession.

As such, the Fed’s current approach to monetary policy should cement its credibility as an inflation fighter and preserve its decision-making powers after the election.

People, not everything is partisan politics.

In closing.

The Fed sees the good news on inflation during the past several months and wants more. It’s already March, and it’s increasingly clear that the Fed will wait as long as possible to cut. Another five months of reasonably good news should build confidence and consensus. July 31 would check the boxes.

Of course, the world could change dramatically before then. It did in March 2020. The Fed would change course if it did. My base case for 2024 is good: inflation down and unemployment low (regardless of rates). But the risks abound, especially from the Fed.

I am cautiously optimistic that we will have that pool party.

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