Goldman Sachs outlook for the May Federal Reserve meeting: The threshold for interest rate cuts is higher than in 2019, and we need to wait for employment and other hard data to weaken

Under the shadow of the trade war, the Federal Reserve's attitude towards interest rate cuts has become increasingly cautious, with a need for hard data such as employment to weaken before triggering a rate cut.

At 2:00 AM Beijing time on May 8, the Federal Reserve will announce its May interest rate decision. The market generally expects the Federal Reserve to remain on hold and continue to pause rate cuts, even in the face of increasing pressure from Trump to cut rates.

According to news from the Chase Trading Desk, Goldman Sachs' Jan Hatzius and other analysts stated in a recent report that compared to the trade conflict in 2019, the FOMC seems to have set a higher threshold for rate cuts. Currently, inflation and survey-based inflation expectations are much higher, and policymakers need to see more convincing evidence of an economic slowdown before taking action.

Goldman Sachs believes that the strongest argument for a rate cut would be if Federal Reserve officials believe the data indicates that the unemployment rate may continue to rise. This means that signs such as rising unemployment, weak wage growth, and companies becoming cautious or weak demand growth need to be observed.

"New Federal Reserve Correspondent" Nick Timiraos also pointed out in a recent report that faced with the dilemma of economic recession and inflation pressure, the Federal Reserve will be more inclined to "maintain inflation," while closely monitoring changes in the labor market and using employment data as an important reference for its decisions.

Higher Threshold for Rate Cuts: The Federal Reserve is More Cautious Compared to 2019

Federal Reserve officials have recently emphasized the risks of tariffs to their dual mandate, but they have stated that they are in a favorable position to wait for further clear information before taking action.

Goldman Sachs expects that at this week's May FOMC meeting, Powell is likely to reiterate this message and use the balanced language he employed in mid-April to describe potential future actions by the FOMC.

Goldman Sachs believes that compared to the trade conflict in 2019, the FOMC seems to have set a higher threshold for rate cuts. Currently, inflation and survey-based inflation expectations are much higher, and policymakers need to see more convincing evidence of an economic slowdown before taking action.

Goldman Sachs stated that if the FOMC believes the unemployment rate will continue to rise, high inflation will not prevent the FOMC from cutting rates, as one-time tariff-driven price increases are unlikely to trigger sustained high inflation during economic weakness.

Divergence of Soft and Hard Data: Waiting for Employment Market Confirmation Signals

Currently, U.S. economic data shows a severe divergence: survey data, or so-called soft data, has rapidly and significantly deteriorated, especially regarding future outlook expectations, while hard data has not weakened overall.

However, Goldman Sachs pointed out that Federal Reserve officials and investors remember that in recent years, survey data has issued "false alarm" signals regarding recession risks, so they want to see evidence from the labor market and other hard data before cutting rates.

Notably, the April employment report showed hiring exceeded expectations, and the unemployment rate remained unchanged at 4.2%. Financial conditions have only tightened slightly, which reduces the urgency for the Federal Reserve to cut ratesGoldman Sachs research believes that the strongest reason for a rate cut will be if Federal Reserve officials interpret data indicating that the unemployment rate may continue to rise. This means that signs of rising unemployment, weak wage growth, and companies becoming cautious or other signs of weak demand need to be observed.

If the signs of weak hard data can be intuitively linked to the effects of the trade war, then these signs will be more persuasive. For example, a decrease in job vacancies or a decline in capital goods orders may help persuade the FOMC that companies are freezing hiring and capital expenditures due to trade war-related risks.

Goldman Sachs Forecast: Rate Cut in July, Three Cuts This Year

Overall, Goldman Sachs' Federal Reserve forecast path is more dovish than market expectations.

Goldman Sachs believes that by the time of the July FOMC meeting, enough hard data evidence will have accumulated to prompt the committee to cut rates by 25 basis points, with another cut in September and October. This would bring the federal funds rate down to 3.5-3.75%. If tariff escalations have stopped by then and the economy has stabilized, the Federal Reserve may consider this a reasonable level.

Current pricing in the futures market points to a 25 basis point rate cut at the Federal Reserve's meeting on July 29-30, with two to three more cuts by the end of the year. However, economists surveyed by Bloomberg only expect two cuts starting in September.

Overall, Goldman Sachs' Federal Reserve forecast path is more dovish than market pricing, reflecting their belief in a higher recession risk due to trade tariffs and trade policy uncertainty.

For investors, it is important to closely monitor hard data such as employment reports, job vacancies, and capital expenditure orders in the coming months, as these will be key triggers for Federal Reserve actions