US: Fed two-rate cut scenario alive. The year has been characterised largely by a disappointing pace of disinflation, delaying the Federal Reserve’s easing policy. Data in the first three months, in particular, were worrisome with the personal consumption expenditure (PCE) deflator, both headline and core, rising by around 3.5% (q/q, s.a., annualised). From rentals to financial services, healthcare to entertainment, services inflation appeared to be regaining momentum.

From the vantage point of mid-June, the worries have faded somewhat. Both core PCE and trimmed mean PCE went back to the path of steady disinflation in April, while May headline CPI was essentially flat, surprising on the downside. Market pricing for two rate cuts has returned as a result.

A couple of years of high interest rates should dampen economic activity. Leveraged households and corporations, finding financing costs prohibitive, tend to cut back on spending, while creditors see default risks rising. But that has hardly been the case in this cycle, with retail sales holding up, housing prices at an all-time high, credit spreads narrowing to record levels, and stocks scaling new heights month after month. Although fiscal policy is playing a moderating role this year in propping up demand after the 2020-23 largess, the US economy’s consumption and investment engines are humming.

Unsurprisingly, the index of real economic activity, representing the common component of ten different daily and weekly series covering consumer behaviour, the labour market, and production, is tracking 2.5%+ GDP growth in 2Q24. A reckoning may be coming for the asset markets and elevated interest rates could dampen sentiment at some point, though concurrent and leading indicators do not show that to be imminent.

We think by the time of the September Federal Open Market Committee meeting, the Fed will have sufficient benign price data from goods and services, including food, energy, financial services, rentals, and healthcare, to start cutting rates. A December cut would follow, in our view.

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