Why the Fed might need to “get on with it” and cut interest rates

The Federal Reserve expects to cut interest rates only once this year. The latest round of monthly data has some economists concerned that it won't come soon enough.

May retail sales data revealed that the pace of consumer spending is slowing from a year ago, alleviating concerns about an economy that is overheating in the fight against inflation. In the labor market, while job additions last month were higher than expected, the unemployment rate reached 4%, the highest level since January 2022. Overall, the Citi Economic Surprises Index, which measures the extent of data emergencies, came in better than expected and hovering near Lowest levels in more than a year.

Meanwhile, inflation data for May was more promising than expected. The headline consumer price index (CPI) rose at its slowest pace since July 2022. When combining this data with the May wholesale price reading, economists believe the Fed's preferred measure of inflation, the personal consumption expenditures (PCE) index, rose at its rate. The slowest pace of the year is during May.

With inflation falling and the economy slowing, Renaissance Macro's Neil Dutta believes it is time “for the Fed to get on with its work” and start cutting interest rates soon. Dutta says this will help protect the Fed's other mandate in addition to price stability: maximum employment.

“The momentum behind core inflation will likely continue to ease from here,” Dutta told Yahoo Finance. “Then I think for the Fed, the trade-offs with the labor market become a little bit more difficult.”

Dutta points out that any sign of weakness in the labor market so far is seen as a sign of rebalancing after the pandemic sent supply and demand spiraling out of control.

Federal Reserve Chairman Jerome Powell admitted this.

“We see a gradual cooling and a gradual move towards a better balance [in the labor market]“We're watching it carefully for signs of something more, but we're not really seeing it,” Federal Reserve Chair Jerome Powell said on June 12 after the central bank's latest policy meeting.

But what matters to Dota, And the economics team at Goldman Sachs, is where the data usually goes from here. The job opening rate is now in line with pre-pandemic levels. If it falls further, a rise in the unemployment rate usually accompanies a downward trend, Dutta said, referring to the Beveridge curve.

like Action of the Federal Reserve highlightspoints on the Beveridge curve moving more along the right axis (as shown in the chart below highlighted in red) will come with diminishing chances of a soft landing, and perhaps a recession.

The story continues

“I don't think the Fed really wants to push the weakness in labor demand that far,” Dutta said.

He added: “The Fed knows that. It's not as if the risk at this point is that the unemployment rate will fall unexpectedly. The most likely distribution of outcomes is that it will be flat or rise.”

To be clear, Dutta and other economists are more interested in how economic data picks up from here rather than where it is today. Many are not overly concerned about current trends yet.

Matthew Luzetti, chief economist at Deutsche Bank, told Yahoo Finance that “risks” in the labor market exist. But at this point, it looks like the American consumer's purchasing power is slowing toward a normal pace, not trending downward.

“Although there are some pressures, especially for parts of households, I would be surprised if you saw a slowdown in the labor market and a slowdown in the consumer that was enough to get them to cut back by September,” Luzetti said.

From a stock perspective, investors have taken the Fed's current expectations in stride. The S&P 500 (^GSPC) and Nasdaq Composite (^IXIC) were on a series of record closes. Three stock strategists boosted their year-end forecasts for the S&P 500 as technology companies continue to perform better than expected.

But one of those strategists, Scott Krohnert, equity strategist at Citi US, highlighted that the economy's “deterioration around the edges” will remain a point of interest for investors moving forward after corporate executives were “cautiously optimistic” during first-quarter earnings calls.

“We'll be watching that closely,” Krohnert told Yahoo Finance. “I think, overall, what we'll see as we get into the second-quarter reporting period is a little bit more evidence that the lagged effects of raising federal interest rates to this point are starting to impact fundamental activity. So, we've got to be aware of that.”

Some worry that the Fed, in being cautious about inflation, may inadvertently wait too late to act and damage the economy. With excess savings dwindling and credit card delinquency rates rising, Mohamed El-Erian, chief economic advisor for Allianz, told Yahoo Finance that small businesses and low-income households, already struggling amid rising interest rates, could be left out to dry.

El-Erian said that the balance of risks for the Federal Reserve, if it waits until the end of the year to cut interest rates, “is in favor of being too late and for the economy to slow down more than it should.”

Josh Schaeffer is a reporter for Yahoo Finance. Follow him on X @_joshschafer.

Click here for in-depth analysis of the latest stock market news and events that move stock prices.

Read the latest financial and business news from Yahoo Finance