Markets have already priced in a Fed cut, given the mixed
economic data in the July labor and CPI prints. Our Global
Economist Arunima Sinha makes the case for why we’re standing by
our baseline call for a higher bar for a rate cut.
Read more insights from Morgan Stanley.
----- Transcript -----
Arunima Sinha: Welcome to Thoughts on the
Market. I'm Arunima Sinha, Global Economist at Morgan
Stanley.
Today – our evaluation of the Fed's policy path following the
July CPI print, and the broader implications for other central
banks.
It's Wednesday, August 20th at 2pm in New York.
Our baseline call has been that the Fed will remain on hold this
year, and last week’s CPI print has not changed that view. As we
have noted, average tariff rates are still ramping up given the
implementation delays, and so their cumulative effect on prices
could be more lagged. Within the CPI print, tariff exposed goods
other than apparel and autos continued to be firm. The surprise
came in services inflation, which showed a reversal led by the
uptick in airfares and hotel prices, which had been running in
deflationary territory for much of this year.
Some of the pushback against our view on inflation stepping up
over the summer due to tariffs was that services disinflation
could compensate. But as this print showed, that is unlikely to
be the case. While we expect services inflation to continue to
moderate, we think that services disinflation in the first half
of [20]25 was exaggerated by weakness and volatile competence;
and both core CPI and core PCE inflation are still at their pace
from last year.
So further acceleration in goods inflation from tariff effects
over the summer would still see inflation remaining well above
the Fed's target. After the July U.S. employment and CPI reports,
the bar for the Fed to stay on hold in September is clearly
higher.
So, what are the risks to our call?
The road goes back to how the data and the Fed's reaction
function will evolve over ahead of the September meeting. The
August jobs report will be important. If it is a solid employment
report, with a sequential acceleration in payrolls and the
unemployment rate around 4.2 to 4.3 percent, then the Fed could
likely look through the weakness in the May and June prints –
attributing the slowdown to the uncertainty following Liberation
Day and not representative of the underlying trend.
If, however, there were to be a sharp drop off in the hiring
pace, which is currently not being indicated by other job market
indicators such as jolts or claims, then the Fed could take the
view that the labor market is much weaker than anticipated and
restart easing. There is also the possibility of a cut from a
risk management perspective.
Even with inflation running well above target, the Fed could take
the July employment report as a clear signal of downside risk to
the labor market and start the easing cycle. Messaging from Fed
officials has so far been mixed, with some taking signal from the
jobs data and others remaining less worried with the unemployment
rate remaining low.
Outside the U.S., central bank trajectories remain tightly linked
to both the Fed's path and the evolving U.S. growth outlook.
Recent labor market data have introduced downside risks to our
ECB and BoJ calls.
In Europe, if Euro strength persists and U.S. recession risks
rise, our euro area economists see a reduced risk to their
September easing baseline. In Japan, the Bank of Japan remains
cautious. Stronger U.S. data could tilt the balance toward a rate
hike later this year – though October remains a high hurdle,
making December or beyond more plausible. That said, if the U.S.
economy slows in line with our forecast, the likelihood of
further BoJ tightening diminishes reinforcing our base case – the
BoJ staying on hold through end of 2026.
Thanks for listening. If you enjoy the show, please leave us a
review wherever you listen and share Thoughts on the Market with
a friend or colleague today.
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