Fed interest rate cuts are coming, but may not be by much

(The Center Square) – This week's economic data is expected to reflect a robust U.S. consumer, helped by moderating growth in rents, groceries and gasoline prices. With a smaller share of loan officers reporting tighter lending standards, bank lending is unlikely to be a drag going forward.

But will inflation continue to fall? Has the Federal Reserve implicitly raised its inflation target?

Retail sales and sales of existing and new homes in July surprised to the upside, helped by easing inflation and falling mortgage rates. Consumer spending remains robust, as the upcoming personal income and spending report is likely to show. Personal savings remain low, and private consumption is expected to have risen 0.5% in July, compared with 0.3% in June. Private consumption was 5.2% higher in June than a year ago, just below the 5.3% in May. The Fed's preferred inflation gauge, the core PCE price index, is expected to have risen 0.2% in July, unchanged from the previous month.

While the Fed's willingness to cut interest rates at its next meeting is welcome news, there is little in the economic and financial data to suggest that further significant disinflation could occur.

First, the stock market has largely recovered from an early August sell-off, returning to mid-July highs. Treasury yields have fallen, leading to a significant easing in financial conditions in August. Layoffs remain near record lows, and with population growth slowing, labor supply will soon reach its limits, limiting further wage disinflation. In addition, fiscal policy is expected to have an inflationary effect by pushing up spending without offsetting tax increases that reduce households' disposable income.

In short, while monetary policy may be tight, it may not be tight enough to warrant significant Fed rate cuts. Markets currently expect the Fed funds rate to fall to 3.25-3.5% by the end of next year. However, if my assessment is correct, long-term US Treasury yields may already be near bottom.