Investors are confident the Federal Reserve will be lowering interest rates by the end of its September meeting.
As of Tuesday morning, markets were pricing in a 100% chance of an interest rate cut in September, per the CME FedWatch Tool, up from a 70% chance a month ago.
The increased confidence comes after a better-than-expected June inflation reading combined with signs of further cooling in the labor market. In sum, economists and investors alike have taken the data to mean the Fed will begin cutting interest rates soon as inflation falls closer to the Fed’s 2% target.
“Recent data have showed a continued softening in the labor market and substantial cooling in inflation pressures, importantly in the all important shelter category,” Deutsche Bank chief US economist Matthew Luzzetti wrote in a July 12 research note, which included a projection for a September rate cut. “These developments should materially impact the outlook for monetary policy.”
Fed Chair Jerome Powell said on Monday that recent data has added “somewhat” to the central bank’s confidence that inflation is falling to its target. However, the Fed chair declined to specify what exactly that means for the Fed’s cutting timeline.
“I’m not going to be sending signals on any particular meeting,” he said. “We are going to make these decisions meeting by meeting and the evolving data and the balance of risks.” Powell said during an interview at the Economic Club of Washington.
Given the recent string of improving inflation data while the labor market has shown signs of slowing, some on Wall Street have been clamoring for the Fed to begin cutting interest rates before their impact on the US economy sends the labor market into a tailspin.
In a new research note on Monday, Goldman Sachs chief economist Jan Hatzius argued there’s “a solid rationale” for the Fed to begin cutting at its next meeting on July 31.
“First, if the case for a cut is clear, why wait another seven weeks before delivering it,” Hatzius wrote. “Second, monthly inflation is volatile and there is always a risk of a temporary reacceleration, which could make a September cut awkward to explain. Starting in July would sidestep that risk.”
Hatzius also noted that while the Fed has pledged its independence from the upcoming election, cutting in July would avoid further speculation about a political motive behind its policy decisions. As of Tuesday morning, two weeks until the Fed’s next meeting starts, investors are pricing in just a 7% chance of a cut in July, per the CME FedWatch Tool.
Whether July is a possibility or not, investors now feel confident that the path forward for interest rates is lower. The confidence that cuts are coming soon has driven more breadth in the stock market rally.
The most-loved areas of the market of the past year have underperformed as investors rotate into sectors outside of tech.
The Roundhill Magnificent Seven ETF, which tracks the group of large tech stocks that led the 2023 stock market rally, is down more than 3% in the past five days. Meanwhile, Real Estate (XLRE) and Industrials (XLI), both interest rate-sensitive sectors, have been the market’s biggest winners over the same time period, rising about 5%.
The small-cap Russell 2000 (RUT) index is up more than 10% and finally breached its 2022 high for the first time during the current bull market.
“If this trade continues, if the prospect for a rate cut is still in play for this fall, then we could finally see the bull wake up, and that’s good news for all investors,” Ritholtz Wealth Management chief market strategist Callie Cox told Yahoo Finance on Monday.
Josh Schafer is a reporter for Yahoo Finance. Follow him on X @_joshschafer.
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