What if... The Fed cuts rates by next summer?

Hello, welcome to another webinar from us at ING Global Research Team. James Smith. An Economist based here London. Now, today we're talking about the Fed, who, of course, kept rates on hold last week, causing some investors to... Question the American Central Bank's commitment to its inflation. fighting credentials. We're going to be talking about what would happen Markets do, if the Fed does hike rates this year. What would happen if it doesn't? What if what could get it to cut rates in 2020? Seven, what inflation outlook. would need to get us there. And of course, what does it all mean for the dollar? This is the second part of our... summer webinar series where we're trying to look at big market consensus themes and look at how they can be turned on their heads. Now today... I'm joined by two speakers. We've got... James Knightley, he's our International Economist. He's normally based in New York, not today, but normally based in New York. And here in the studio London, we've got Francesco Bizzoli. He's our FX Strategist, and he's here to talk about the dollar. in a little bit. But before we get into all of it, let's start with a poll of what you're thinking about right now. And it's a simple one. Do you expect the Fed to hike rates in 2026? Yes or no? We'll come back to the results of that in a few moments time. But James. We're going to get into what's going to happen with interest rates in a few moments. But let's start with that meeting from last week because There's a pretty widespread view out there that Kevin Walsh's press conference has left investors... A little bit confused. Maybe there were some conflicting messages in there as well. What did you make of it? What do you think Walsh's premiership holds for the Fed over the next few months? I don't think anyone has an issue with the results or the decision on its own. The Markets going into last week's meeting pricing about a third. want a chance of a rate hike. Economist were much more confident there would be a no change outcome. But as you say, it was that price. conference where there was a sense that But going into that, we knew Kevin Walsh was going to try and Play down the forward guidance. perhaps he was more evasive than was expected. And I think it was the lack of... a sort of a framework as to what is the fed's reaction function from him. So that uncertainty led Markets thinking Well, actually, is the Fed alive to the risk of inflation as much as we'd like it to be? and that did see the long end sell off to some extent as well. So that anxiety, that uncertainty, the lack of... clarity on the thinking within the Fed. has created a bit of a void. And so we've gone from one extreme where he was very and see. forward guidance because it thinks it leads to groupthink, it thinks it leads to This lack of volatility to one of the other extreme where we've got no clarity. No. real certainty about what the Fed is thinking. what the Fed is doing and that risk going the other way isn't too much volatility. Now, I think the interesting thing actually is post that press conference. we've had despite kevin walsh wanting the fed to speak less we've had a number of fed officials coming out and providing their own personal reaction function and the hawks and surprisingly saying yes we should of heights because of this reason that reason but um The people are not who didn't vote for a hike are also starting to outlay their thinking much more. detail it is one whereby their base case is that they think inflationary pressures will continue to moderate but if they don't then they will have to change their mind and will have to vote tonight so i think Looking at it right now, Markets pricing of perhaps a 55-60% chance of a hike. It's September, it's not real surprising given that we have got two jobs reports. and to inflation reports still to come. James we'll come back on to what Markets pricing and what you're thinking for the Fed in more detail as well. Let's dig into inflation a little bit firstly. one of the big issues for obvious reasons is oil prices and gasoline has It's been above four dollars a gallon over the last few days again. across the states. I mean, how big an issue is that going to be for inflation this summer? Well, I think it's more about where we go with oil prices. Right now there is Clearly some optimism that a deal is in the process of being agreed that can deliver supply or resumption of supply. through the straights of home use. So we've got oil prices moving low again. So Brent's about $80, West Texas about $75 a barrel. And that's historically is consistent. With gasoline prices actually falling. So yes, we're above $4 a gallon now. But I would actually caution that I think we've got a bit of a dampener coming through. in terms of refining margins so if you remember we dropped below 70 ...dance a barrel very briefly on West Texas. Now it's historically consistent with... Gasoline prices dropping to $3.50 a gallon. in the united states we got nowhere near that we bottomed at about 3.85 backup now at about four dollars and ten. So we've had a modest increase. But in aggregate, we're still well below where we averaged through. And I still think that gasoline can act as a... as a factor that helps Sampson inflationary pressures when we get that July inflation report next week. And if we can indeed get a deal, then I think that is... certainly what our base case would assume. We're going into the midterm elections in November. It's going to be growing. Political pressure on Donald Trump to relieve the financial stresses. on US electorate as we head towards that and that means getting a deal getting a resumption flow of oil and getting lower gasoline prices so right now yeah a little bit of anxiety but I think that we can still see gasoline prices acting as a dampener. in the July report next week and as I say I think we can get lower energy prices. and we can also head towards a... a lower contribution from inflation coming through from that. respect Okay, so energy is one bit of all of this, James, but there's plenty of other stuff been happening in the inflation mix. Tariffs is... is another obvious one. What other drivers are going to be relevant for inflation over the next few months? Well, I think in terms of that story, we're looking at a number of factors. So we would argue there's four points that can lead to a lower energy story. What is that energy? factor. The second one of course is housing. Housing is the biggest component of the inflation basket with a weighting of about 35%. It's got about 42% of the... the core inflation basket as well. Obviously. So given that situation where we've got house prices barely rising... 1% now nationally in the United States. And we've got growing evidence of cooling rents and a growing number of states are actually... Reporting outright rent falls right now. And there is a lag between that and the CPI component. So I still think that that can really help to Sampson. and inflationary pressures or the headline inflation readings and core inflationary The next point is wage costs. This cost input for corporate America is not the cost of energy, it's not the cost of tariffs, it's not the cost of money. It's the cost of you and I and unfortunately the cost of you and I is not going up all that. We know from average hourly earnings They're running at an annualized rate of about 2.9%. ...from the Employment Cost Index that we got last Friday. Private sector wages are only rising 3.1% year on year. These are pretty benign prints. And today's unit labour cost data. Kenny Outs, 1.3% annualised rate for the second quarter in a row. That is... really really low so there's no inflationary pressures of any meaningful sense coming out of the jobs market And then the fourth point that we make is tariffs. Tariffs were seen as the big inflationary impulse. ...the last 12 months. But we're now arguably in a Pesole, lower... tariff rate regime following the notification of the IE EPA. Liberation Day tariffs. And in fact, actually, what we're seeing is tariff refunds and those tariff refunds Refunds are now more than offsetting. the actual tariffs raised from the current regime. So we've got a net cash flow boost over the last couple of months and that's going to continue perhaps in the next two or three months as well. And that cash flow boost can really help mitigate cost pressures that may be elsewhere. ...in the supply chain. So for me... I still think that we can see some pretty benign. or more benign than we have seen inflation readings coming through. And that's... I would argue is still going to be enough for them to narrowly decide not to hike rates in September. If they don't hike rates in September, I think that the probability... starts to make even further rate hikes later in the year and into next year. James, just to pick you up there on wage growth, obviously quite an important factor. And the Fed hawks will probably say, well, Look, we've got payrolls growth that has been accelerating again over the last few months. Is the next logical step of that reacceleration not a pickup in wage growth. What would you say to that? Yeah, I mean, I would say, you know, we averaged employment growth of about Eight and a half thousand a month between January of 2025 and February of this year. Okay, that was... incredibly low. Now we had some better prints for March, April and May. but the June report came in at less than half what was expected and we saw 70% four thousand damage emissions to two months before that. So to argue that we're in a massive rebound in hiring I think is a little bit of an exaggeration. If we look at the employment indicators The ISM manufacturing number on Monday, the employment indicator did improve. But the services from yesterday was really weak back in the day. contraction territory. We're going to get the National Federation for Independent Businesses, the small business. sector survey of jobs later on today. That's expected to be pretty weak. Currently, we're at the lowest levels when you ignore the three months around it. Pandemic craziness where people are being laid off dramatically. It's the lowest for 10 years. So I don't think we can say that... The survey evidence is pointing to a a resumption of huge hiring. So for me, We've got a situation where we've moved from from 2022, where there were two job vacancies for every single unemployed American. to a situation today where we're completely in balance. There's one jump vacancy. for every American. The quits rate has collapsed as well. So there's no turnover coming through. So that lack of vibrancy, I think, is... apparent in many, many indicators now. So I'm I'm pretty relaxed about the idea that we're going to be seeing widespread wage inflation. It'd be great. It'd be really good, but I don't see it. That's all. You mentioned that the jobs Markets more balanced, but one market that is very much not balanced right now is the one. for chips and semiconductors you alluded to it a minute ago we are starting to see some of those items go up. I mean, here in the UK, the cost of everybody's smartphone. has risen quite sharply over the last couple of months. Is that going to be a big driver of inflation? It certainly gets the headlines. And, you know, when you see the iPhone is going to go up $100, Xbox $100. It's $150. your MacBook going up, all those sorts of things. Yeah, it's one of those big ticket items that people notice and people are aware of. It's not quite like milk or bread or gasoline, but it's getting there. It's one of those things that People are sort of aware of the pricing around it. Now, the counterpoint to that is that the chips that go into it are just one aspect of the cost. Moreover, the weightings within the inflation basket are critical. And that's why I made the reference to housing earlier. Housing is awaiting 35%. Now, If we look at what the weighting of computer and peripheral equipment is within the inflation. It's 0.299 percentage points. adding telephones smartphones and other calculation devices which is a separate category that's got a weighting of 0.41 so in combination of all of those tech related items that are going to be suffering from chipflation as you call it. It's a weighting of 0.7 percentage points. points within the basket. So it's very low. So it's going to rise pretty markedly to really drive inflation. higher. And the other point I would make is that US adopts what they call hedonic pricing. So it's quality adjusted. And that's why, you know. if you look at the price of smartphones, they haven't changed over the last 12 months. If you go into a... A smartphone retailer of choice. you'll see that you pay the same price this year as you paid last year right now. Yet within inflation, the inflation metric is that smartphones have fallen 12.7% year-on-year in price. And that's because they quality adjust. You know, the smartphone today can do a lot more than a smartphone from... five years ago and therefore although the price hasn't changed The fact that you're getting more bang for your buck. delivers a lower inflation print. So I think, you know, one sort of interesting side point is that You know, if we start to see the price of smartphones rise, we just don't buy the smartphone because clearly the Bureau for Labor Statistics don't think the quality improvement you're getting is worth it. price just by an older model. So I think combining that point, the low weighting and the fact that they adopt some hedonic pricing is yes the inflation rates are going to look higher but is this going to drive inflation meaningfully higher than the Fed has to hike. I'll be talking to you later. Now, let's check in with a poll from a few minutes ago, James. Now, Markets pricing, fully pricing a rate. hike by the end of this year. The audience, however, Very 50-50. I'm getting like Brexit referendum vibes here. Sort of like 51, 52. 48. So very close call either way. Knightley edging it. James mentioned the inflation outlook, what needs to happen on inflation for the Fed not to hike? in September. But another consideration here is who is going to vote for a hike, right? Because back in June, the headline was... nine out of the 18, 19 committee members. are looking or penciling in a rate hike by the end of the year. Yeah, only three of them actually voted for a hike. in July. So there is a bit of a question mark, isn't there, as to... is there actually a majority among the 12 voters that vote any one time? Yeah, I think that's the critical point. I think, you know, when we look at the speeches, the commentary from the officials, So we can try and figure out, we can. You know pretty well. who the nine are that say they think they're going to hike. And who the nine are that says, well, we don't think. We need to hike. And of course, Kevin Walsh didn't submit. a submission and there's a strong suspicion is that He will be in there. I don't think that there were height caps. That would make it 10 to 9. on the face of it in June. And since then, of course, the inflation data has been really good. i.e. coming in much lower than expected. We've got that zero core. month-on-month and got the minus 0.4 headline And of course, we've got the jobs number, which was much weaker than expected. So you would think that that helps the argument for no hike and that's why they didn't hike. in July. Now, if we look at those nine that think that they're going to hike, Well, we think that three of them are the ones that voted for the hike. The other six are non-voters this year. So they're not going to be at the September meeting. They're not going to be voting at the December meeting. They're only going to get some of them. are going to come in for the January. meeting as we get a bit of a switch up. So the key story to delivering a rate hike is getting elevated inflation that convinces those that don't think that they need to hike. Actually, we do need to hide. So it's not the other way around. It is much more about convincing people that they need to change their view. and they need to hike. And that's the challenge. And if we do, as I say, see those four catalysts for lower inflation. the proximity to the midterm elections delivers a deal that delivers Lower energy costs for the electorate. We see the housing story continue to Sampson inflation. I see the tariff mitigation effect, the tariff refunds. helping offset cost increases elsewhere limiting. the need for higher prices and of course the benign wage story. I would argue that I would still lean in the direction of a no change this year. And I think that's where... the Fed, the voting members. of the Fed this year currently are. So it's much more inflation has to justify the higher. story. Thanks, James going to come on to Francesco in a few moments. One final question. For you though, the whole premise of this webinar. is what's happening or what could get us to rate cuts in 2027. That is still... kind of notion of your call isn't it for the from the middle of next year The whole debate here is really how restrictive are the... interest rates right now. And there is a bit of a debate at the Fed, isn't there? Some Fed hawks who point to the Fed. The fact that we've had that payrolls acceleration. maybe actually the current level of interest rates isn't as restrictive. what's your view on that and what could get us to cuts next year? Yeah, I mean, as the poll just showed, it's a very, very close call. And I think it is a very close call. It is going to be a very close call as to whether the Fed hikes. or not because we need to see that real disinflation trying to continue for next year. You know, in general, my sense is that We're in for a prolonged pause. There's no real need. I would argue from the way that I see the data heading over the next 12 months, for the Fed to change policy rates. I think we're... We're okay. You know, 375 right now. or 350 to 375 is above where the Fed tells us they think effectively mutual is. You know, they've got a long run target. on their forecast for where the Fed funds rate is over the longer term is about 3%. 0.1% and we're well above that. So That's why I think, you know, we'd lean in the direction, where are we going to go from here after? Is it more likely to be a hike or more likely to be a Well, when you've got the Fed telling us that they think in the long run, the Fed funds rate is going to be 3. I would have to say, I would argue that it's going to be a cut and that's why I've got a cut notionally in there. With very, very low conviction, you know, we could see rates stay on hold for a very prolonged period of time. Now, why is it also that I would lean in the direction of a cuts? Well, again, you know, Kevin Walsh's mindset is that AI and technology advancement is going to be a productivity boost to US economy and that will allow US economy I need to grow faster without generating inflation. and should in theory mean neutral interest rates are going to be lower. than where they are today. So that is another argument. breakouts and I think that there is buy-in from the Fed in general. If you remember back in the previous set of Forecasts updates. The Fed revised its long-term growth forecast for US from 1.8% to 2%. percent without changing its inflation so i think there is some buy-in from the Fed on the technology investment. generating a meaningful boost to US economy that can mean Growth can be faster without generating inflation. And of course also, you know, Looking at the supply chain strengths, you know, we've got to hope and think that they're going to ease, you know. i.e. the energy story in the Middle East. That's going to alleviate some of the supply chains and other things such as such as fertilizer and other aspects plastics, etc. And also chips, you know, although I'm saying inflation in the chip stories a little bit. Overplayed, you know, these things go in boom and bust cycles. We've seen it over the decades in the chip industry. And that's something that these chip companies themselves are anxious about. as well is that we will see a ramping up in supply. And you've got to think that the data center rollout The rampant frenzy data center will gradually cool. and that supply chain pressure, which is putting some pressure on other prices in this. in the system should also abate as well. So low conviction call, but in general, I would lean in the direction that eventually... the Fed will cut rates after a long pause. All right. Thanks a lot, James. James International. Economist. Now, let's come on to the dollar before we get on to Francesco, who's here in the studio. So another poll for you. Where do you see Eurodollar in a year's time? We've given you various brackets. It's ranging from below 105 right through to above 125. As before, we'll come back to the answer to that. Have a little think, put in your answer. We'll come back to that in a few. moment's time now uh Francesco the dollar didn't really like what it I heard at the press conference last week with Kevin Walsh, it sold off. afterwards. I mean, I think what we've seen, James kind of alluded to earlier, is the Markets simultaneously... banking on fewer rate cuts. So that was the impact reaction, but also questioning the Fed's kind of commitment to its 2% inflation target. lots of different things have been driving. the dollar. this year but does this tell us that it's rate differentials that really matter again for FX? Yeah, I think it confirms that it's very differentials that really matter for FX now for Eurodollar. You know, one way to look at it is to look at the Could the standardized beat us on a... on a regression model is one way us in research tend to to try and understand what is currently driving. currency pair. Now normally in In G10 currency pairs, you would see short-term rate differentials being consistently the most important drivers. But obviously that can change pretty rapidly. And we saw it happen in March and April. when obviously oil prices took over. very rapidly. And for some weeks, it felt like that everything that was happening in central banks didn't matter all that much. It was all about. You know, the next headline about US Iran war, what followed was Obviously, you know, the headline fatigue markets. really growing frustration on the back of uncertainty of where this situation would go. And what happened inevitably was that rate differentials became more and more important. And crucially, that happened at a time Markets started to think that the Fed would be able to hike. Great. That was a tangible possibility. So what we've seen now and then happened. well before the July meeting by the Fed was this. rise in the betas, the coefficients in our models. of short-term rate differentials. And indeed, what we've seen... after that press conference that you mentioned. in the past week, in the past 10 days, sort of. Well, it has been a situation where oil prices have fallen. roughly $15 looking at Brent. And the dollar hasn't really reacted much to it. So what we continue to see Markets really... Being very focused on the short-term rate differential story. the Fed story. So I think tomorrow's payrolls. probably matter much more for euro dollar than the next headline about US. around negotiations. So let's take that one step further then. So rates differentials are what? Matt, as we've heard from James view on the Fed, we don't think the Fed's going to... hike rates this year could even cut rates next year our ecb call is that we're going to get one more hike in September. What happens when you marry that all together and map that onto your Eurodollar forecast? Yeah, so when we come up with our forecast, obviously, we look at a number of variables and we look specifically at how correlations have... behaved and how we think they will behave in the future. And obviously the fact that at the moment, short-term rate differentials matter so much, and we think they will probably continue to matter. in the coming quarters, then we're obviously taking on board this Fed... call and and we're basing most of our dollar views uh on that fat call and obviously on the ec to be cool as well. So when we plot through like that, you know the two years swap rate differential which is a very good gauge Markets expectations for the Fed and the ECB and how we think those will shift. when our FED and ECB calls sort of like materialize. obviously that implies a tightening of that spread. between you know interest short-term interest rates in the us and short interest rates in the eurozone and the tightening of that spread should drive euro dollar higher. So we published new forecasts today, just a few hours ago, and we're keeping... our year-end target for Eurodollar unchanged. At 1.18, we're looking for further gains into next year, obviously on the view that ultimately at one point next year, the Fed will start to cut rates. Yeah, and let's just check in with the poll from a few moments ago. Where do you see Eurodollar in a year's time? It looks like... most people sort of generally agreeing that euro dollar is going to go higher most of you expecting euro dollar to be between 115 and 119 so a bit higher from where we are today in a year's time but lots of views out there Francesco I also want to ask you about the yen uh very topical this week we've also got a poll on that incidentally which I'm sure will pop up in a few seconds time, which is where do you see dollar yen? and a year's time so the same question we've got ranges from below 150 right up to above at 165. So let us know what you think about that. But it's been a big story, right? This week, it's very unusual that US and Japan intervene or have this. coordinated International. The general vibe on International tends to be that it doesn't really last that long in terms of its impact. So if the authorities in Japan really want to get dollar yen lower. what needs to happen. Yeah, I think, you know, you're right. It's very rare that, you US... um authorities and and japanese authorities intervened last time it happened um it was 1998, so quite a long time ago. I think what's important is what Scott Bassett said this week. He is expecting... the Bank of Japan to deliver the policy follow-up to International. That really tells us a lot on how Everybody is very well aware that this is just a temporary fix to a structural issue. And the only way this structural issue of a weakening of the yen, especially against the dollar. is the only real long-term fix is obviously... faster, larger policy normalization in Japan. And after those comments, Vice Court best in Markets pricing in over 50% probability of a high. in September by the Bank of Japan, then any other measure that Japan can deploy in terms of encouraging, incentivizing. investing in domestic assets. that would help. But ultimately, and that's the thing that Japan has no control over, is the Fed story. So, you know, when we look at dollar-yen at the moment, we have a short-term target of 160. We think there's still a bit of... room for a rebound in the next few weeks. But then we have it coming back lower to like 158 and ultimately back to 155. in the next few quarters. And that's mostly on the back of our Fed story. because if indeed the Fed does not hike and then heads into WriteCast next year, then the environment for... dollar yen will look much softer. Obviously, if the Fed does end up hiking in September, then it will be quite hard for dollar-yen. to trade lower and the chances that they will have to intervene again will rise. quite dramatically. Yeah, quite a lot of moving parts there actually and it's interesting when you look at the poll results here. quite a spread of views really as to where dollar yen will be in a year's time most of you think between 160 and 164 so International and the Japanese authorities efforts. not really working. But yeah, pretty interesting spread of views there. We're going to come to your questions now. We've got a couple of... minutes left. We've got one here, Francesco. Quite a good question. So all sort of Kevin Walsh's thing is that he doesn't like forward guidance, right? And he's not even telling us anything. So how does that sort of feed into markets? rates, but also FX. if the Fed isn't really telling us what it thinks, if it's more likely to surprise us on meeting days. How does that weigh into the outlook? Well, it means more volatility. It means more volatility around any data release. because what James mentioned at the start was like one of the issues with can't be worshipped for his comfort. This wasn't just the lack of forward guidance. We knew he wouldn't be giving forward guidance. was the lack of indications about what the reaction function of the Fed is. at the moment to data. And that is something that now Markets missing. So it's a bit of free for all, you know, trying to speculate what the next. data release will mean for. Markets the other thing is volatility associated with any off-meeting comments by other FOMC members. I think Kevin Walsh's plan can make sense if he could fully control, you know, the rest of the FMC and what they say outside of meetings. Obviously he cannot at the moment. And so what this means is that. obviously Markets much more flexibility to price in and out rate hikes. or rate cuts at a later stage. And this means more volatility. potentially around those events, data releases. and and fat speeches and obviously the the the meeting itself for the dollar for uh FX and rates Thanks a lot, Francesco. Francesco, our FX Strategist based here London. Lots of good questions here. I think hopefully we've answered most of them as we've gone through and we are up for time now. One final thing. Do join us next Thursday. for our next webinar. That's going to be hosted by Rebecca Byrne. It's all about AI. How's it being financed? Of course, that's been a huge story recently, hasn't it? But also, how's it being powered? and the sort of resources it's consuming. in the power grid and everything associated with that. So it's going to be good fun. Next Thursday. There's a link to the right-hand side of your screen now to get yourself signed up and we'll have more episodes. Episodes of this are what if summer webinar series later in the summer. You're already on the list for that having signed up to today. So keep an eye out for updates on that. All that leaves me to say is thanks to both James and Francesco for joining us. here today and also to you for tuning in. Speak to you again next time. Goodbye.