Yesterday, we got the last two key economic reports before the FOMC meeting and they made the case for an insurance 50 bps cut stronger.
Here's why...
The US CPI came in line with forecasts, and despite some worryingly hot details in the report, it likely wasn't enough to give the committee a reason to start slowly on rate cuts. Moreover, WSJ's Timiraos shared on his X account (@NickTimiraos) the PCE estimates following the PPI and CPI reports, and they look much better than the CPI. Remember that the Fed targets the PCE and not the CPI.
In fact, Core PCE M/M is expected to rise by just 0.20% vs 0.35% in the CPI and the Core PCE Y/Y is seen remaining unchanged at 2.9% vs 2.9% last month. In the PCE, core goods prices are expected to have declined, while in the CPI report they actually rose.
Inflation is certainly a concern for the Fed, but they also made it very clear that the labour market is more important for them. And that's where the reasons for a 50 bps cut considering everything get stronger.
The US initial jobless claims yesterday spiked to a new cycle high and to the highest level since 2021. There are very good reasons to expect them to come down next week as yesterday's data might have been just a blip given that it was negatively skewed by an unusally big spike in Texas.
But the problem is that the Fed can't be sure if it was indeed just a blip and can't have strong conviction in such a call given that we had two consecutive soft NFP reports.
Last year, we had something similar when we got a soft NFP report and the Fed decided to cut by 50 bps as an "insurance cut" in September in case the labour market deteriorated further. Also, the chances of a 50 bps cut weren't strong going into the meeting back then, too. They increased substantially after a WSJ article written by Nick Timiraos, who is widely seen as the Fed whisperer (and also nicknamed "Nickileaks").
Timiraos will certainly write another article on the Fed decision before Wednesday, so activate notifications for his X account and keep an eye on his updates. There might be something like "given the recent weakness in the labour market data and fear of a quick deterioration, the Fed might debate whether a 50 bps insurance cut is warranted". Anything pointing to a debate on 50 bps cut should increase market's probabilities significantly, and eventually be followed by the 50 bps cut on Wednesday to avoid a hawkish surprise.
Whether that would be the right or wrong decision is debatable, but central banking is also about risk management and they might think that cutting by 50 bps now and then watching how things evolve could be the better plan. In case they cut by 50 bps, they will highly likely label that as an "insurance cut" and then the market will continue to be a slave to the data for the next moves and interest rates pricing.
To sum up, I'm expecting the Fed to deliver a 50 bps insurance cut next week. But in case they decide to go with a 25 bps move, expect to get a strong dovish pledge to support the labour market in case the data deteriorates further (which could mean a 50 bps cut in October if labour market data continues to soften).
