Powell opened the door for the Sept rate cut, but it's not a done deal

Outlook

In the US today, we get July durable goods orders, June house prices, and two regional Fed surveys (Richmond and Dallas).  The Fed Question is probably going to override anything these have to say about the US economy.

Before diving into the real stuff, consider that one cause of the equity indices closing in the red yesterday was Trump firing Fed Cook, plus (probably) yet more tariffs. The stock market generally ignores politics but if the drop yesterday was in fact most influenced by the prospect of the Fed losing independence, that’s a signal. Trump won’t like being blamed for tanking the stock market. Complicating things is Nvidia tomorrow, which could do it, too. But if Nvidia earnings are okay and the stock market is still slumpy, you have to wonder if TreasSec Bessent will tell Trump that he needs to back off the Fed.

That we even consider this reprieve from Trump is a good indicator that the Sept cut is widely accepted. The CME FedWatch has the probability at 84.2% this morning, from 83.7% yesterday and 61.9% a month ago.

Powell opened the door for the Sept rate cut. But he didn’t shove the other voting members through it. It’s not a done deal, no matter what experts say. It’s not authentic forward guidance and may well be independent of Trump’s pressure. As we wrote yesterday, we don’t know what the data will bring and we also don’t know how wily Mr. Powell may be. He’s a lame duck, to be sure, but even Trump naming his successor (before the Sept meeting) is just noise. The press is framing the firing of Fed Cook as a critical tipping point, but we suspect the Fed has more supporters of independence than Trump is reckoning. Some of them may be big movers in the equity market.

On the data front, the critical factor is jobs. Is the labor market falling into the slough of despond? Companies are not firing all that much but they are not hiring, either, and the US continues to have a labor shortage, only exacerbated by the assault on immigrants, legal and otherwise. A stagnant labor market implies lower economic growth, so a cut is the right move. And slow growth can point to moderating inflation. In short, there is a decent story here.

We get the PCE on Friday. See the chart from Heisenberg, aptly named the boiling frog. Inflation will be 2.9%, the most since Feb and nearly a full point over the target. But, not to be a spoilsport, look at the data quarter-over-quarter—looks like a downtrend.

We can also fiddle with m/m or monthly annualized. In that case, June was the same as May. The picture shifts with every chart. So, yes, you can make the case that while inflation is probably rising a little, it’s not a catastrophe just yet, and if Powell is right that it will be a one-time and transitory effect, the rate will go back to decent levels.

That’s the rate of change. As for the level of prices, they will stay high, just as food prices have stayed high after the 9% gain during Covid. The rate might be smallish, but the level counts, too, especially in perception by the Average Joe.  It’s not clear how the level is viewed by the Fed, which seems to focus on the rate.

And as the excellent Authers points out, the swaps makret expects stable inflation, but inflation over 3%. This is not good news for the doves. The labor market has to be really dreadful to offset that rate of inflation. And given the revsions that just shocked us all—a downward revision of 258,000 for May and June, leaving the jobs added at a lousy 33,000 over two months. This is a justified spur to revising our thinking. And the long-term jobless rate (continuing claims) just hit the highest in over three years. Labor shortage? Something is going on that none of us can grasp.

But is it enough? What if we get nicely strong jobs and inflation a tad higher than expected in the next releases? Bottom line, nothing is a done deal if all we are looking at is data.

But the Trump threat to the Fed is very real. El-Erian writes in the FT that the Powell speech was a “tactical manoeuvre” to signal the near-term outcome without addressing the all too real questions about the economy. He is leaving it to his successor to face the key issues. Never mind what those are—El-Erian is a savvy guy and if he says, like so many others, it’s a Sept cut, the probability is high it’s a Sept cut.

But we like the sane and reasonable ECR position in the debate. Here’s a takeaway. 

As we expect the US economy to continue growing at a reasonable pace and expect inflation to rise towards 4% in the near term, we believe markets will grow concerned about excessive inflation before the end of the year. Further rate cuts would then become highly problematic. It would therefore not surprise us if markets soon price in a short-term rate of just under 3% for the end of 2026, but that it will fairly quickly become clear this is greatly exaggerated.

As for the yield on 10-year US government bonds – currently around 4.3%: it is quite possible that it will fall in the period ahead, in tandem with the short-term rate, to around 4.1% or even 3.9%. If this does not happen, this in itself would be an alarming sign of how investors view public finances and inflation. Whatever the short-term path, sooner or later we expect the 10-year yield to start an uptrend to (well) above 5%, driven by growing fears of inflation and runaway public finances and a declining willingness among foreign investors to invest large sums in the US.

This is the same as our outlook but not the timing we would embrace. The bond and FX markets are far more impatient than to wait for the end of 2026 to express dissatisfaction with rates. But it does seem likely that the 2 and 10-year will be falling before they start rising, and if not, it’s a signal the markets do not like or trust the Fed.

Remember that when Trump fired Cook, the 2-to-30-year Treasury yield curve moved to its steepest since January 2022. Does this mean the bond vigilantes are just biding their time?

Forecast

It’s unfortunate that the dollar index tracked the Fed/Cook story yesterday, falling on the firing and recovering on the Cook refusal to accept being fired. It implies that going forward, the index will be influenced by politics.

That puts the standard pullback in jeopardy, as we see already on the charts.  We can’t say how long the pushme/pullyou will last.

But at some point we are in for a big, fat reversal. Take a look at the weekly chart. We never haver any luck with cycles, but if history is a guide, the euro is coming up on another rally. Nobody knows when and it might depend on the Trump battle with the Fed or another of his ridiculous, uninformed checkers moves.

A giant euro rally is not good for those economies but just as important, it would imply the loss of credibility and desirability of the dollar that is so clearly in the works. This could mean a battle of the bond vigilantes against the bigger crowd that sees stagflation or even recession and wants those multiple rate cuts, inflation be damned.  

We suspect Trump will win the Cook case (since the Supremes gave him carte blanche), and also that he will name a Powell successor in the next month or two, cementing the politicization of the Fed. The markets are already showing they do not approve. They may not like the Fed, but they would despise a Trump Fed. Yields will rise, the dollar will fall, and the stock market may tremble.

Food for thought: Nobel economist Krugman makes the extreme case of the Trump-Cook situation:

Powell has the right—"I would say the obligation — to say, ‘Show me the legal basis for this action.’ If Trump’s officials can’t provide that basis, he should declare that as far as he is concerned, Cook is still a Fed governor.

“If Powell caves, or the Supreme Court acts supine again and validates Trump’s illegal declaration, the implications will be profound and disastrous. The United States will be well on its way to becoming Turkey, where an authoritarian ruler imposed his crackpot economics on the central bank, sending inflation soaring to 80 percent.”

This is an excerpt from “The Rockefeller Morning Briefing,” which is far larger (about 10 pages). The Briefing has been published every day for over 25 years and represents experienced analysis and insight. The report offers deep background and is not intended to guide FX trading. Rockefeller produces other reports (in spot and futures) for trading purposes.

To get a two-week trial of the full reports plus traders advice for only $3.95. Click here!