Goldman Sachs called the Fed's rate cut in July "more desirable," betting on three rate cuts this year

After Goldman Sachs indicated that the conditions for easing have matured, traders have increased their bets on the Fed cutting interest rates three times this year.

The market has fully digested the expectations of two 25-basis-point rate cuts in 2024, with Monday's market implying a probability of around 60% for a third rate cut. It is widely expected that the Fed will cut rates for the first time in September, but Goldman Sachs economists believe there are "compelling reasons" for officials to cut rates as early as July.

Weaker-than-expected employment and inflation data in June have fueled expectations of rate cuts. After recent data confirmed that a rate cut in July is reasonable, bets on rate cuts have accelerated under the leadership of Goldman Sachs Chief Economist Jan Hatzius. The bank still predicts that the first rate cut will take place in September.

Hatzius summarized in a brief report: "The FOMC has an undeniable motive (though never acknowledged), which is to avoid starting rate cuts in the last two months of the presidential election. This does not mean the committee cannot cut rates in September, but it does mean that a rate cut in July is more preferable."

Hatzius first pointed out that the core CPI in the U.S. only increased by 0.06% in June, confirming that the first-quarter rebound was an outlier, partly due to residual seasonal factors.

He wrote: "Based on CPI and PPI (excluding import prices), we estimate that the monthly inflation rate for core PCE in June was 0.19%, while the market's core PCE was 0.15%. The Dallas Fed's adjusted average PCE monthly rate may have also risen by 0.15%, and on a 3-month annualized basis, it has now returned to the low point at the end of last year. We expect further moderation in July and August data, partly due to the relatively persistent weakness in the housing component (which may be particularly pronounced in the July report as housing inflation is calculated based on a 6-month average growth rate, and January was a high outlier)."

Hatzius said that assessing the strength of the U.S. labor market requires sifting through a large amount of seemingly contradictory, and sometimes distorted, data. But the bottom line is clear. While layoffs remain restrained, the unemployment rate is gradually rising as recruitment efforts are not sufficient to absorb all local and foreign-born new labor. So far, Fed officials have welcomed the rise in the unemployment rate, but "we agree with Powell's assessment that the labor market has now fully rebalanced."

Hatzius said: "We may be approaching a turning point, at which further weakness in labor demand will lead to a greater increase in the unemployment rate, which is not so welcome."

He pointed out that recent U.S. employment surveys have been weak, GDP growth slightly below trend, with an estimated average growth rate of 1.6% in the first half of the year, all of which are worth noting. "Based on the latest unemployment and inflation data, we estimate that the median of Fed staff's monetary policy rule now implies a fund rate of 4%, well below the actual rate of 5.25%-5.5%." Based on this observation, the encouraging CPI in June, and Powell's testimony in Congress last week, Goldman Sachs' team expects rate cuts to start soon. Hatzius said, "The market almost entirely expects a rate cut at the FOMC meeting on September 17-18, which is still our base case. However, we believe there are good reasons for a rate cut as early as the meeting on July 30-31."

Hatzius presented three reasons for a rate cut in July:

First, if the reasons for a rate cut are clear, why wait another seven weeks to implement it?

Second, monthly inflation rates are unstable, always carrying the risk of temporary reacceleration, which could make a rate cut in September difficult to explain, while starting in July could avoid this risk.

Third, the FOMC has an undeniable motive to avoid starting rate cuts in the last two months of the presidential election.

However, the market is still skeptical, with pricing for a rate cut in July remaining low.