Inflation risks linger, beware of the "false start" of the Federal Reserve's interest rate cut cycle
Despite the market's high expectations for interest rate cuts, Bank of America pointed out that the core inflation rate may soon exceed 3%. Factors such as tariffs are exacerbating upward price pressures. If the Federal Reserve acts hastily, it may fall into a "stop-and-go" policy dilemma, bringing more uncertainty to the market
Goldman Sachs and Citigroup call for a 50 basis point rate cut is not without possibility, but Bank of America advises everyone to stay calm.
According to the news from the Wind Trading Desk, on August 6, Bank of America warned in a research report that the persistent inflation risk in the U.S., particularly the core Personal Consumption Expenditures (PCE) price index, may soon break through the 3% mark, making any premature rate cuts by the Federal Reserve a potential "false start."
As a result, the bank maintains its judgment that the Federal Reserve will keep interest rates unchanged this year. The report points out that despite a recent slowdown in employment data, the fundamental issue facing the Federal Reserve is inflation. The core PCE inflation rate has remained stagnant at 2.8% over the past year, which is 80 basis points above the Federal Reserve's target of 2%.
Bank of America's simulations indicate that the core PCE inflation rate could reach 3% as early as July. They believe that as tariff costs are increasingly passed on to consumers, the inflation outlook risks are "firmly skewed to the upside," requiring the Federal Reserve to remain patient in deciding its next policy move.
This prediction may even be "too optimistic." Analysts at the bank point out that since the effective tariff rates are stabilizing above their current assumptions, this means that the peak level of inflation could be higher, staying above 3% for a longer period, and potentially triggering nonlinear effects that put upward pressure on inflation expectations.
This judgment is based on a core fact: over the past year, despite the Federal Reserve maintaining high interest rates, core inflation has not effectively declined and remains sticky.
Price Pressure Highlights
Recent U.S. economic data paints a complex picture, but the signals of upward price pressure are clearly visible.
The latest ISM services index in the U.S. fell to 50.1 in July, indicating weak expansion momentum, with declines in both new orders and employment components. However, the price paid index in the same survey surged by 2.4 points to 69.9, indicating that cost pressures on businesses are still increasing.
Many surveyed companies expressed concerns about the uncertainty brought by tariffs, believing that tariffs are causing project planning delays and rising costs.
The Ghost of "Stagflation" Emerges Patience is Key
Given that inflation risks are firmly skewed to the upside, Bank of America's economist Stephen Juneau clearly stated that it is "prudent" for the Federal Reserve to remain patient.
Bank of America also warns that if the U.S. economy is facing a "mild stagflation," where economic growth slows while high inflation persists, the risk of hasty rate cuts is extremely high.
Such a move could force the Federal Reserve to pivot again soon, creating a "stop-and-go" easing cycle. This policy flip-flopping would not only damage the Federal Reserve's hard-won anti-inflation credibility but also bring more uncertainty to the market. For investors, this means being prepared for interest rates to remain elevated for a longer period.
Goldman Sachs and Citigroup: 50 basis points under consideration
In stark contrast to Bank of America's views, the latest employment data from the U.S. shows that the U.S. economy and labor market are sharply slowing down, leading several Wall Street investment banks to be convinced that a turning point in the Federal Reserve's policy is imminent.
An article from Wall Street Journal reported that investment banks such as Goldman Sachs and Citigroup are predicting that a 25 basis point rate cut by the Federal Reserve in September is the baseline scenario, and if non-farm payrolls worsen further, a more aggressive 50 basis point cut may occur in September, with the final policy rate potentially dropping to 3% or even lower.
At the same time, dovish forces within the Federal Reserve are gathering, possibly clearing the way for earlier and faster rate cuts.
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