FOMC divergence is rare in 27 years, and employment unexpectedly collapses! Will the Federal Reserve's "wait-and-see" eventually turn into "action"?

According to Zhitong Finance APP, at the beginning of this year, after experiencing "hawkish rate cuts" (i.e., consecutive rapid rate cuts, with the first round significantly lowered by 50 basis points), the Federal Reserve maintained interest rates at peak levels and shifted to a "wait-and-see" strategy, which sparked strong dissatisfaction among rate cut advocates, including President Trump. Trump has been pressuring Federal Reserve Chairman Jerome Powell on this matter for months.

On July 30, the Federal Reserve again decided to keep interest rates unchanged. However, during this meeting, two governors—Bowman and Waller—broke ranks and voted against the decision. Notably, this is the first time since 1993 that the Federal Open Market Committee (FOMC) has seen such a degree of dissent, although the final voting result remained 9:2.

Meanwhile, the employment report released the day after the Federal Reserve meeting caused market turbulence last Friday, as this weak employment report completely changed futures market expectations. The market's expectation probability for no rate cut at the September Federal Reserve meeting plummeted from 35.4% a week ago to 10%, with the remaining 90% probability pointing to a 25 basis point rate cut.

The Dawn of Rate Cuts Appears

In fact, no one anticipated such a drastic market change, including Jack Bowman, founder and investment advisor of Bowman Capital Management, which is also the reason for the market sell-off triggered by the significant downward revision of employment data on August 1. The actual labor market is much weaker than expected, with the cumulative employment numbers for the previous two months revised down by 257,000. Compared to historical data, this revision is the largest since the COVID-19 pandemic, and further back, it dates to the global financial crisis.

Although this does not signal an economic apocalypse, it does reflect the enormous uncertainty faced by businesses. Rapidly changing tariff situations and other political issues continue to trouble the business community, and the unresolved China-U.S. negotiations have exacerbated the tense atmosphere.

The magnitude of the second revision of May data is equally shocking. The U.S. Bureau of Labor Statistics typically makes two revisions to monthly data, but the second revision is usually minor; however, this revision set the record for the largest second revision since 1983 (excluding the 500,000 revision during the pandemic).

Bowman believes that this change provides the Federal Reserve with the long-awaited policy basis. Previously, the Federal Reserve repeatedly emphasized that "the labor market is too strong to lower interest rates," but the situation has now reversed.

The only variable: inflation

However, Bowman added that if inflation data worsens before the next Federal Reserve meeting, even a weak labor market may force the Fed to hold steady. He believes that if the inflation rate rises above 3%, it can be expected that the futures market, which is attentive to the Fed's movements, will significantly lower its expectations for interest rate cuts, even believing that there will be no cuts.

But based on the latest data, the path to rate cuts still seems clear. The Consumer Price Index (CPI) rose in June, but its sustainability remains in question; the Core Personal Consumption Expenditures (PCE) Index (the Fed's preferred inflation indicator, excluding food and energy prices) remains at the levels seen in the months leading up to "hawkish rate cuts."

The housing sector also shows positive signals: the Case-Shiller Home Price Index indicates that the rate of increase in home prices for 2024 is gradually declining. Due to the Federal Reserve maintaining a "moderately restrictive" high interest rate policy, mortgage rates remain high, which indirectly leads to stagnation in housing inventory in recent years (homeowners are reluctant to give up low-interest loans to switch properties). However, with supply increasing for two consecutive months, the pace of home price increases is slowing. Bowman stated that if this trend continues, it will have a positive impact on inflation data and may be one of the reasons for inflation continuing to stabilize.

GDP dynamic observation

In terms of the economy, GDP significantly rebounded after negative growth in the first quarter due to a surge in imports, but the 3% increase mainly stems from abnormally low imports, as companies stocked up on inventory in the first quarter to cope with tariff fluctuations and are currently digesting that inventory, thus reducing imports.

Bowman stated that net exports made a significant contribution to GDP in the second quarter, so it is still necessary to wait for imports to return to normal levels to accurately assess GDP trends.

Conclusion

Currently, all signs point to the Federal Reserve lowering interest rates in September. Although Bowman has always believed this is the Fed's established plan, the unexpected downward revision of employment data in May and June has confirmed this direction.

The only factor that could potentially prevent a rate cut is a resurgence in core PCE inflation. However, trends such as a slowdown in housing price increases and an increase in supply suggest that inflation may stabilize. Given that companies across the supply chain have prepared for known tariff rates (at least for the EU, Japan, and other countries), without new triggering factors, it is unlikely that CPI and PCE will see significant declines. Closely monitoring this data will be key to predicting the variables for a rate cut—otherwise, in light of the latest employment report, a rate cut has become inevitable