Bank of America sticks to its guns on Fed interest rate forecast

According to market predictions, the long wait for the Federal Reserve to lower interest rates may soon be over.

CME's closely watched FedWatch tool uses the futures market to predict rate-cut odds. It currently pegs at 93% the probability that at the target="_blank" kwlink="6384064000816950219725">target="_blank" kwlink="6384064000971585773080">central bank's next meeting, on Sept. 17, Fed Chairman Jerome Powell will lower the Federal Funds Rate by 0.25 percentage point.

That figure is up from 55% one month ago, due to weaker-than-expected July unemployment data released in early August.

And that in turn is encouraging to those hoping for interest-rate relief on mortgages, credit cards and auto loans.

However, not everyone is convinced that a rate cut is a certainty, particularly after the July Producer Price Index, which measures wholesale goods prices, called into question the thinking that the impact of the Trump administration's tariffs on inflation is minor.

It's true that consumer-level inflation, as measured by the Consumer Price Index and Personal Consumption Expenditures Index, has risen only marginally since the tariffs were enacted.

But in July PPI inflation sharpened much more than economists expected, which is worrisome because higher prices at the factory gates are considered a precursor to consumer inflation.

If so, the Fed may remain boxed in by its dual mandate, as Bank of America analysts suggest in their latest update on the likelihood of a September cut.

The Fed gets boxed into a corner on interest rates

Plenty of economic warning signals are flashing:

• Unemployment is at 4.2%, up from 3.4% in 2023.
• Inflation is sticky, with CPI inflation rising since April.
• GDP is weakening, with projections of 1.4% in 2025.
• Consumer sentiment in August retreated.

The Fed is boxed in by its twin goals of setting interest rates at levels that support low inflation and low unemployment — two often contradictory mandates. Raising rates lowers inflation but increases job losses, while rate cuts have the opposite effect.

This means the Fed's job is more complicated than it sounds, particularly this year, given all the crosscurrents.

The unemployment rate has inched steadily higher since 2023 because of the Fed's hawkish rate hikes in 2022 and 2023. Meanwhile, inflation (nicely lower than its peak three years ago) has seen progress stall since the administration's tariff announcements this spring.

In July, the unemployment rate increased to 4.2%, or more specifically, 4.248%, dangerously close to being rounded up to 4.3%, which would have been the highest level since late 2021.

The Consumer Price Index in July showed headline inflation was 2.7%, up from 2.3% in April before many of the tariffs kicked in. Meanwhile, Personal Consumption Expenditures inflation was 2.6% in June, up from 2.2% in April.

Adding to the mixed bag of conflicting economic data, the World Bank estimates GDP, which measures economic activity, will grow just 1.4% this year, half the figure of 2024.

The University of Michigan's latest Consumer Sentiment Survey Index fell 5% in August to 58.6 due to nervousness about future inflation and unemployment.

“Consumers continue to expect both inflation and unemployment to deteriorate in the future. Year-ahead inflation expectations rose from 4.5% last month to 4.9% this month,” said University of Michigan Surveys of Consumers Director Joanne Hsu.

“This increase was seen across multiple demographic groups and all three political affiliations. Long-run inflation expectations also lifted from 3.4% in July to 3.9% in August.”

Bank of America doubles down on 'no-cut' in September after PPI shocker

The conflicting economic data may mean markets are too optimistic that the Fed will cave and lower rates to prop up the job market in September, especially after the PPI data showed that wholesale level inflation was increasing.

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According to the Bureau of Labor Statistics, which produces the inflation report, the PPI grew 0.9% in July, the largest increase since June 2022 and well above economists' 0.2% consensus forecast.

Headline PPI inflation grew 3.3% and the index for final demand minus volatile foods, energy, and trade services increased 2.8% in July year-over-year, “increasing 0.6% in July, the largest increase since rising 0.9% in March 2022,” according to the BLS's statement.

“Given today's [Aug. 14] PPI and Tuesday's CPI data, we are tracking core PCE to rise by 0.3% month over month (0.3% unrounded) in July,” wrote Bank of America analysts to clients. “This would push the year-over-year rate up to 2.9% from 2.8% previously.”

Core PCE, which removes the impact of volatile food and energy, is the Fed's preferred measure of inflation. So, an increase in expectations is moving in the wrong direction for those expecting rate cuts, particularly given the Fed's inflation target of 2%.

“In our view, this challenges the market's conviction for a September cut, and we retain our call for no cuts this year,” said the analysts bluntly.