The interest rate cut game under the shadow of tariffs: the market bets on easing in September, but the Federal Reserve is stuck in a "wait-and-see" phase

According to the Zhitong Finance APP, a series of encouraging U.S. economic data last week showed signs of easing inflation, and consumer confidence rose for the first time this year; the overall labor market remains robust, with the unemployment rate holding steady at a healthy 4.2%, although the rise in the number of people applying for unemployment benefits indicates some signs of cooling in the labor market. Overall, the current economic backdrop seems to support the Federal Reserve's gradual shift towards a looser policy. However, Wall Street observers believe that policymakers may still need more signals before implementing any rate cuts.

Former Cleveland Fed President Loretta Mester stated in an interview last Thursday, "We don't really know how the second half of the year will play out," adding that while recent "hard data" such as employment and inflation reports are encouraging, "the real question is what will happen in the second half of the year and whether these trends will continue, which is where we still face a high degree of uncertainty."

The current uncertainty mainly revolves around a series of tariff policies announced by U.S. President Trump on the so-called "Liberation Day" of April 2 and thereafter, which have caused significant turbulence in the markets and among businesses. Since then, many so-called "reciprocal tariffs" have been suspended, but the 10% baseline tariff imposed on most countries remains in effect. Trump will notify U.S. trading partners in the coming weeks of the unilateral tariff rates they will each bear.

Meanwhile, Mexico and Canada still face tariffs related to fentanyl, while industry tariffs on steel, aluminum, and automobiles remain unchanged. Earlier last week, the U.S. and China reached a framework and enforcement plan aimed at easing trade tensions. However, many market observers pointed out that the agreement lacks details.

Mester stated, "The Federal Reserve will remain on hold until we get more information about the scale and scope of the tariffs, their impact on inflation, and how these policies (including the budget bill) affect growth and employment."

"Wait-and-see phase"

Despite these cautious remarks, market confidence in an imminent rate cut is growing. Nearly 70% of investors are now betting that the Federal Reserve will begin cutting rates in September, up from 60% a week ago. According to predictions from the Chicago Mercantile Exchange (CME), as of last Friday afternoon, the market estimated the probability of a rate cut in July at about 25%. However, the market has almost fully priced in that the Federal Reserve will keep rates unchanged at this week's policy meeting.

Brent Schutte, Chief Investment Strategist at Northwestern Mutual Wealth Management, stated that for a rate cut to occur before September, the labor market may need to deteriorate significantly. He also warned that inflationary pressures have not fully dissipated, especially in the context of unclear tariff impacts. He said, "Some people believe that tariffs will not bring inflationary pressure; I think it's too early to draw conclusions now." "To cope with tariffs, the behavior of importers, consumers, and businesses stockpiling in advance may be affecting the current inflation data. Such effects typically take time to reflect in actual data." Brent Schutte added that the Federal Reserve is currently in a "wait-and-see phase." He stated, "In my view, it is unlikely that the Federal Reserve will cut interest rates before September unless you see a significant deterioration in the labor market, at which point the question becomes 'Will it be too late?'"

HSBC U.S. economist Ryan Wang also pointed out that tariffs have created "two-way risks"—while commodity prices may continue to rise throughout the year, early signs of cooling in the labor market could offset some of the upward pressure on prices by pulling down inflation.

Despite the market betting on a smooth path for interest rate cuts, Ryan Wang warned that the Federal Reserve needs to ensure that inflation does not rise in a "runaway manner," while overall economic activity does not deteriorate rapidly. He noted, "A moderate path for interest rate cuts still needs time to take shape."