The Fed's Rate Cut Path: Inflation, Tariffs, and Economic Scenarios

Inflation Outlook and Fed Policy

• 💡 The upcoming CPI report is a key market mover, with hopes for contained inflation that could allow the Fed to consider resuming rate cuts later this year.
• ⚠️ The Fed's decision hinges on the impact of tariffs and administration policies on prices and jobs.
• 📉 The least likely scenario involves inflation marching higher with no decline in unemployment.
• 📈 The most likely scenario suggests higher unemployment with stable to lower inflation.
• ⚖️ A potential dilemma is stagflation (higher inflation and higher unemployment), where some believe the Fed might cut rates to focus on jobs.

Potential Rate Cut Scenarios

• 🎯 The Fed will likely wait to confirm that tariffs are not leading to broader inflation.
• 💰 Stable or lower inflation could enable the Fed to remove approximately 50 basis points of restrictiveness.
• 💸 If inflation heads lower or unemployment rises, the Fed could cut rates by as much as 100 basis points.
• 📊 The market is pricing in a middle scenario of 50 basis points in cuts, with roughly 62% probability for cuts in September and December, though conviction is low.

Small Business Sentiment and Tariffs

• 📈 The NFIB small business report showed a modest rise in optimism, but firms planning to raise prices remain elevated.
• 🔑 If tariffs do not significantly impact the data, it could clear the way for Fed cuts, but this trend needs to continue for several months for the Fed to gain confidence.

Economic Growth and Fed Caution

• 🗣️ There's a noted contradiction in administration rhetoric, advocating for 3% growth while suggesting the Fed should cut rates.
• 🚀 Potential positive economic catalysts include reduced tariff uncertainty and administration policies like R&D expensing, which could boost growth.
• 🚦 In a scenario of strong economic growth, the Fed might maintain its restrictive stance rather than easing policy.

CPI and PCE Expectations

• 📊 Expectations for tomorrow's core CPI are around 0.210% or potentially 0.310%.
• 🎯 A rough estimate suggests taking half a point off CPI to approximate the PCE, indicating the PCE is moving in the right direction.
• 🔍 The focus will be on dissecting the CPI report for signs of tariff impacts and any offsetting price changes.
• ❓ The ultimate question for Fed officials is whether to take a risk by cutting rates now or to wait for more certainty, with the safest approach likely being inaction until more data is available.