One of the key events this week — assuming the US president does not again hog the limelight with unexpected comments on tariffs or other issues, as he did last week — is the upcoming FOMC meeting on Wednesday, followed by a press conference by Federal Reserve Chair Jerome Powell.
The baseline scenario is that, despite weak 1Q GDP data (-0.3% vs. +0.4% expected) and continued pressure from Donald Trump to loosen monetary policy, the Fed will hold its benchmark overnight rate steady in the current 4.25%-4.50% range, just as it did in December, January, and March.
What’s holding back a rate cut?
Let's start by noting that the recent drop in U.S. economic figures was mainly due to the widening trade deficit. In the first quarter, the gap grew to $12.71 billion, up 12.8% from the $11.26 billion recorded a year earlier, as companies rushed to stock up on goods before the tariffs arrived.
For now, there is no reason to panic, which helps explain the current optimism in the S&P 500 and Nasdaq. That said, it is worth noting that, according to Bloomberg, 75% of economists now expect a recession or flat growth in the U.S. over the next 12 months, up sharply from just 26% in March.
A rate cut is also unlikely given the continued strength of the U.S. labor market. In April, 177,000 new jobs were created, well above the forecast of 138,000. In the private sector, 167,000 new jobs were created (up from 170,000 previously; forecast: 124,000), and the unemployment rate held steady at 4.2%.
On the other hand, there is reasonable concern that Trump's protectionist trade policies could reignite inflation in the U.S. The latest PCE price index data shows 0.0% as expected, down from +0.3% in February. However, the data still does not include the impact of the tariffs imposed in April.
What could change the Fed's mind?
The major warning sign for the economy is the sharp drop in consumer confidence. In April, the Consumer Confidence Index fell from 93.9 to 86.0, while the Expectations Index — which reflects consumers' short-term outlook for income, business, and labor market conditions — plummeted from 66.9 to 54.4.
According to The Conference Board, consumer confidence has fallen to its lowest level since the start of the COVID-19 pandemic. Some 32% expect job losses in the next six months, close to levels recorded in April 2009. Expectations for future earnings have also turned negative for the first time in five years.
What is the current outlook?
Markets expect a rate cut in July, possibly as much as 50 basis points, down from 25 basis points a week ago. Analysts, in turn, expect only two rate cuts this year, probably in September and December, of 25 basis points each. Ultimately, however, the way forward will depend on how the data evolves.