Is the Federal Reserve's rate cut in September stable? Two key data releases may overturn expectations

Federal Reserve Chairman Jerome Powell sent a strong signal for interest rate cuts at the Jackson Hole meeting, but the upcoming employment and inflation data could still alter the established path for a rate cut in September.

In his speech on Friday, Powell clearly stated that the downside risks facing the labor market may "require adjustments to our policy stance," paving the way for the Fed to end its eight-month pause. U.S. Treasury bonds and the stock market surged on the news, with the yield spread between 2-year and 30-year Treasury bonds widening to its highest level in nearly four years. Futures market pricing suggests that the probability of a 25 basis point rate cut in September is currently around 75%-80%.

However, several Fed officials and Wall Street economists have warned that the employment and CPI data for August, to be released on September 5 and 11, will be key factors in determining the rate cut in September. Boston Fed President Susan Collins publicly stated that "what we will do at the next meeting is not yet set in stone," while St. Louis Fed President Alberto Musalem pointed out that current inflation is closer to 3% rather than the Fed's 2% target.

Key Data Will Determine Rate Cut Pace

Powell's speech at the Jackson Hole annual meeting cleared the way for a rate cut next month. He emphasized that the risks posed by high borrowing costs are increasing and could harm the job market, indicating that a rate cut could happen as early as September.

Stephen Brown from Capital Economics stated that Powell's conclusion that "policy is in a restrictive range, and a shift in the baseline outlook and risk balance may require an adjustment in policy stance" clearly indicates that a rate cut in September is now the most likely outcome.

However, he also noted that Powell's continued cautious stance suggests that a very strong August employment report or more concerning CPI data could still lead to a delay in the rate cut.

Futures traders have not viewed a 25 basis point rate cut on September 17 as a certainty. Futures market pricing suggests that the probability of a 25 basis point rate cut in September is currently around 75%-80%. Even after Friday's rise, bond yields have not broken through the lows seen earlier this month.

Gregory Peters, co-chief investment officer of fixed income at PGIM, pointed out that while Powell "has solidified market expectations for a September rate cut," the "key is not whether the cut occurs in September or October," as the next six months will still be a mixed data environment, keeping the bond market on edge.

Inflation Concerns Limit Long-Term Bond Gains

The yield spread between 2-year and 30-year Treasury bonds has widened to its highest level in nearly four years. With expectations of a rate cut in September, investors are favoring short-term U.S. Treasuries.

Compared to long-term U.S. Treasuries, which are more affected by inflation and government deficit expansion risks, short-term U.S. Treasuries have more certain upside potential after the Fed resumes easing policies.

Padhraic Garvey, head of Americas research at ING, stated, "Short-term bonds now have Chairman Powell's support, and their yields should remain low," but "long-term bonds do not like this situation," which "may reflect doubts about the Fed's willingness to take risks on inflation issues."