Strong Economic Data is Making Interest Rate-Cut Timing Harder to Predict

Increased economic strength is not what the Federal Reserve is looking for as it considers when to start cutting interest rates, but that’s what it has been getting.

On Thursday, initial jobless claims fell for the second week in a row and the Purchasing Managers’ Index rose to its highest level in more than two years, showing increased strength in the manufacturing and service sectors. Both reports came in stronger than economists had anticipated. And in another surprise Friday, data showed that new orders for durable goods increased 0.7% in April, up for the third consecutive month.

The increasingly data-dependent Fed has said it needs confidence that inflation is lowering to its annual goal of 2% before it can cut its benchmark interest rate, and the latest data likely did nothing for that cause, economists said.

“The data yesterday suggests there’s little urgency for the Fed to cut rates anytime soon,” Jim Reid, a research strategist with Deutsche Bank, wrote on Friday.

Fed officials have said they don’t need to see weakness in the economy to cut rates, but signs that it is accelerating could be hinting inflation is growing alongside.

“Comments from Fed officials suggested that a July cut would likely require not just better inflation numbers but also meaningful signs of softness in the activity or labor market data. After the stronger May PMIs and lower jobless claims, this does not look like the most likely outcome,” wrote Goldman Sachs economist David Mericle.

Thursday’s economic releases threw cold water on an early-session surge in U.S. stocks following the release of a blockbuster earnings report from chipmaking giant Nvidia. The Dow Jones Industrial Average fell more than 600 points on Thursday, it’s biggest decline of the year, as investors fretted about what the data might mean for the Fed’s decision-making.

Traders Push Back Rate-Cut Expectations

Traders and economists agree it is unlikely the Federal Reserve will cut rates at its meetings in June and July, but beyond that, the path ahead gets harder to predict.

Traders are now pricing in a 51.3% chance of a cut in September, according to the CME Group’s FedWatch tool, which forecasts rate movements based on fed funds futures trading data. Traders seemed more sure about a September cut a week ago when they priced in about a 65% chance. Goldman Sachs on Friday pushed back its forecast and now expects a first rate cut in September.

Interestingly, a small portion of traders are now pricing in the chance for a potential rate hike in the wake of the strong data and the comments of a few Federal Reserve officials. While traders saw zero chance of a rate hike at any point this year as of last week, strong data has pushed them to price in a 1% chance at both the June and July meetings. After their last meeting, Fed Chair Jerome Powell played down the likelihood of imminent rate hikes.