Fed is weighing much more than inflation: Economist

June's Personal Consumption Expenditures (PCE) reading came in-line with expectations, rising 0.2% month-over-month and 2.6% year-over-year to mark the slowest increase since March 2021.

Bank of America Securities head of US economics Michael Gapen joins Morning Brief to break down the Federal Reserve's preferred inflation gauge and what the current state of the economy signals for interest rate cuts.

"It is another bit of evidence for the Fed to say, 'Yes, the upside that we saw in inflation in the first quarter was largely an aberration. It did not break the disinflation trend.' Inflation appears to be decelerating gradually in the direction that the Fed wants, so now it's a question of how much evidence does the Fed need?" Gapen says of the print.

He believes next week's Fed meeting will provide investors more clarity on the timing of the first interest rate cut.

Gapen adds that Fed officials have "changed their tone in recent months."

"It's now a much more balanced reaction function. It's not just about inflation. The Fed is saying the labor market is back in balance, so further increases in the unemployment rate would tell the Fed that slack is appearing in markets, and reinforce the view that inflation should come down."

He believes that unemployment is rising because growth in the labor force caused by immigration is outpacing the demand. "If the labor market is normalizing, employment growth is moderating, and strong inflows into the workforce mean the unemployment rate backs up, that can reinforce Fed cuts. I would argue it only reinforces gradual cuts, not kind of the deep and rapid cuts you might get in a recession," Gapen explains.

For more expert insight and the latest market action, click here to watch this full episode of Morning Brief.

This post was written by Melanie Riehl

Transcripción del vídeo

Let's talk about how the FED factors into all of this.

With that latest inflation data coming in in line with expectations.

Could this pave the way for the fed to cut rates this fall?

Joining us?

Now we want to bring in Michael Gapen, he's Bank of America Securities, head of us economics and Michael, it's great to talk to you again.

So what do you think of this print and what it might tell us about the timeline for the Fed?

Well, I think you characterized it quite well.

I think this is another bit of evidence and we knew most of this data coming into this report because we had the CP I and the PP I print.

So it's no surprise where this number landed, but it is another bit of evidence for the Fed to say yes.

The upside that we saw on inflation in the first quarter was largely an aberration.

It did not break the disinflation trend.

Inflation appears to be decelerating gradually in the direction that the FED wants.

So now it's a question of how much evidence does the FED need?

When does it get that evidence?

And when does it Act.

So I do think it affirms, as you said, the widely held view that the FED will be reducing rates later this year.

And I think next week it can tell us, yes, it has gained incrementally more progress.

We're moving in the right direction.

We're getting closer, but we're not there yet.

Let's talk about some of that evidence that might roll in.

We just got the latest inflation stats today, but we got two more job reports before the September meeting.

And I believe I've done the calculations if the unemployment rate takes up to 4.2% that triggers the so rule recession warning indicator that we are actually in recession.

Do you think that just gives the fed that much more credibility to raise rates in September?

And then what if we don't get that threshold?

What if the labor market is still relatively robust and we don't get that critical.

So rule trigger before the September meeting?

Right.

Well, cer certainly the fed has changed their tone in, in recent months.

It's now a much more balanced reaction function.

It's not just about inflation.

The fed is, is saying the labor market is back in balance.

Um So further increases in the unemployment rate would, would tell the fed that slack is appearing in markets and reinforce the view that inflation should come down.

Now, I I disagree kind of about using the so rule in this particular cycle and, and so does so does Claudia.

Um I think the the unemployment rate is rising largely because growth in the labor force from immigration is out facing labor demand.

It's not a story about layoffs and rising unemployment because firms are cutting back unemployment and engaging in kind of large scale cost cutting.

So I don't think the s rule applies in terms of recession risk.

But I, I do think if the labor market is normalizing employment growth is moderating and strong inflows into the workforce mean the unemployment rate backs up that can reinforce fed cuts.

I would argue it only reinforces gradual cuts, not kind of the deep and rapid cuts you might get in a recession.