Hold on tight! The first rate cut by the Federal Reserve will still face a wave of data tests

Investors are focusing on the Federal Reserve's interest rate meeting in September, expecting the central bank to start cutting rates. Federal Reserve Chairman Powell said this would mark a "significant" shift in policy, transitioning from a tightening phase against inflation in the pandemic era to an easing phase.

The final outcome is still uncertain, with changes in supply and investment patterns during the pandemic, new geopolitical tensions, and even the potential tariff war that a second Trump administration could trigger, all posing challenges for the Fed to exit high interest rates just as it combats inflation. But at least the first rate cut seems imminent.

However, whether September will be the starting point for rate cuts will depend on whether the data aligns with Fed officials' expectations, including whether inflation continues to decline to the Fed's 2% target, and whether the labor market remains broadly balanced with moderate wage and monthly job growth.

It is expected that the Fed will continue to keep the benchmark interest rate in the range of 5.25%-5.50% at the July meeting, but its new policy statement may also change the description of the economy and outlook, laying the foundation for a rate cut in September.

The gap between the Fed's July and September meetings is 7 weeks, one week longer than usual, allowing the Fed to gather more data. Meanwhile, the Kansas City Fed will also host the Jackson Hole central bank symposium, a venue where the Fed chair often delivers policy-related speeches. New York Fed President Williams recently said in an interview, "We will actually learn a lot between July and September."

Will the Anti-Inflation Process Continue?

After initially downplaying the inflation impact caused by the pandemic as "transitory," the Fed began the fastest rate hike cycle in history starting from March 2022, accepting the view that price pressures will persist and starting to worry about losing public trust.

During the 12 policy meetings, the Fed raised the benchmark interest rate by 525 basis points, averaging nearly 50 basis points per meeting. This included four consecutive hikes of 75 basis points, aimed at signaling the Fed's determination to control inflation to the market.

The Fed's policy rate reached roughly the same level as before the 2007-2009 financial crisis in July last year, and then remained unchanged for a long time. The duration of this "restrictive" rate period may be at the median level of the Fed's recent rate hike cycles.

This is because officials received positive surprises about inflation last year, when supply chains and labor markets began to resemble the pre-COVID era. A significant portion of the inflation shock was indeed proven to be "transitory," just at a slower pace than policymakers initially expected.

Ahead of the July policy meeting, Fed officials indicated that they believed inflation might continue to slow down, and if inflation slows, a rate cut would be appropriate.

According to the Fed's preferred PCE price data, the U.S. May PCE price index increased by 2.6% year-on-year, and many economists expect the year-on-year increase in the PCE price index scheduled for July 26 to drop to 2.5% or lower Before the September meeting, policymakers will receive the July PCE price index on August 30, as well as the July and August CPI data on August 14 and September 11 respectively. Despite concerns earlier this year that inflation was picking up, recent data shows inflation slowing down again.

Can the Labor Market Remain Stable?

Powell recently described the labor market as "balanced," meaning the available number of workers roughly matches business demand for labor; monthly flows of new hires and resignations align with population growth; and wage growth is consistent with the Fed's inflation target.

The current unemployment rate of 4.1% is roughly the level Fed officials believe is sustainable in the long run with an inflation rate of 2%, policymakers hope they can end the inflation struggle and start cutting rates without causing a significant increase in the unemployment rate.

The upcoming nonfarm payroll report will be used by officials to confirm that wage increases and labor shortages no longer pose inflation risks, and if there are significant signs of labor market weakness, this could impact the scale and pace of future Fed rate cuts.

The unemployment rate is currently steadily rising from last year's historic low of 3.4%, with some Fed officials pointing out that the unemployment rate often sharply rises after an initial slow increase.

Ahead of the September meeting, officials will receive the July and August nonfarm payroll reports on August 2 and September 6 respectively. While weekly initial jobless claims data has been on the rise, the data is volatile and heavily influenced by seasonal factors.

Reports on job vacancies and worker turnover levels for June and July will be released on July 30 and September 4 respectively.

Data from job vacancies and labor turnover surveys have played a surprisingly important role in recent Fed discussions, indicating that the pandemic has distorted the labor market. As job vacancies-to-unemployed ratios and other aspects of the reports return to pre-COVID-19 levels, job vacancies and labor turnover survey reports have shaped officials' views on the potential for the unemployment rate to start rising after the Fed has exerted prolonged pressure on the economy