With interest rate cuts off the table in July, why is the Federal Reserve still playing the "waiting game"?

Since the Federal Reserve announced the end of its historic cycle of fighting inflation, people have been paying close attention to when and at what pace it will provide relief to American borrowers.

Federal Reserve Chairman Powell and his colleagues have stated that they need irrefutable evidence to prove that the inflation rate, which has been hovering at a 40-year high, is falling back to the Fed's 2% target. Until then, the Federal Open Market Committee (FOMC) will lack the confidence to start cutting interest rates.

Why is the Federal Reserve hesitant to declare victory?

A series of favorable inflation data, along with signs that the labor market is not as hot as before, indicate that this high standard has more or less been met.

However, senior officials at the Federal Reserve remain hesitant to declare victory. Instead, they believe that waiting for some time before lowering the policy rate from the current range of 5.25%-5.5% will have many benefits.

Skipping a rate cut in July will allow the Fed to collect more data. Powell reiterated this point at a congressional hearing earlier this month, stating that if Wall Street's predictions of further strengthening of the anti-inflation trend come true, it will trigger the threshold for rate cuts.

Between the policy meetings in July and September, officials will receive two sets of inflation and employment reports, as well as a series of other latest information on the cornerstone of the world's largest economy, such as consumer and housing market health.

Given the unexpected rebound in inflation earlier this year, having more concrete evidence about anti-inflation is crucial to quell some officials' doubts about the economic outlook.

Diane Swonk, Chief Economist at KPMG US, said, " They have been fooled before, credibility is important."

After steadily moving towards the 2% target for several months, data for the first quarter showed an unpleasant return of price pressures, casting doubt on the Fed's ability to control inflation and derailing its plans to cut rates at the beginning of summer.

This is the latest in a series of economic surprises that the United States has encountered after the COVID-19 pandemic, in which Fed officials were misled and forced to reconsider their policy settings.

With price pressures rapidly easing again in the second quarter, it is now widely believed that the situation in the first three months of this year was an anomaly, but officials remain cautious about signaling a policy shift too early. In addition, there is still some disagreement among officials about how much the rate should be cut once this process is initiated. Forecasts released in June indicated that the number of rate cuts this year would be between one and two.

The Federal Reserve may pave the way for a rate cut in September

If the door for a rate cut in July is closed, then the door for a rate cut in September seems to be wide open.

Traders in the federal funds rate futures market have already fully priced in a rate cut in September. This meeting will be the last one before the November presidential election, with officials holding two more meetings before the end of the year. Market participants expect at least two 25-basis-point rate cuts this year In the past month, Powell and his colleagues have been increasingly optimistic about the downward trend in inflation. The two most influential people in the FOMC, New York Fed President Williams and Fed Governor Waller, supported this view a week before the scheduled quiet period, claiming that the Fed is "getting closer" to the timing of rate cuts.

As former Fed economist and current President of MacroPolicy Perspectives Julia Coronado said, the Fed is like an "ocean liner," which means that apart from crises, the Fed usually avoids sudden policy shifts.

Coronado expects a "clear" change in the policy statement in July, signaling an imminent rate cut.

The significant shifts in the labor market further confirm this view. The U.S. employment situation, once seen as an accelerator of inflation, is now slowing down.

While hiring remains strong, Americans are finding fewer opportunities for new jobs, and the number of people applying for unemployment benefits is increasing. Wage growth is also slowing down.

Waller recently said in a public appearance, "From now on, I think the risks to the unemployment rate going up are greater than we have seen for a long time." But he also warned that the "uneven" inflation outlook could make the recent rate cut "more uncertain."

Michael Strain, Director of Economic Policy Studies at the American Enterprise Institute, pointed out a concerning issue that the inflation rate may "linger" above the target level of 2.6% or 2.7%, so he opposes Fed action in September.

More importantly, the Fed does not want the labor market to deteriorate further. The Fed also insists that bringing the inflation rate back to target does not necessarily have to result in excessive unemployment.

Coronado said, "Due to the flexibility of the labor market, they originally thought they had enough time to determine the trend of inflation. But this hope is fading."

Jan Hatzius, Chief Economist at Goldman Sachs, even believes that waiting until September for another rate cut would increase the risk of outcomes the Fed is trying to avoid. He said:

"If you wait, there is a possibility of further deterioration in the labor market. Given the magnitude of the changes, why not do what you may have to do anyway in advance?"