FedWatch's Ben Emons on why next week's economic data may reshape rate cut expectations

Key Concepts:

• Inflation (overall, core, and super core)
• Federal Reserve (The Fed) independence, rate cuts, and policy decisions
• Labor data (payrolls, employment)
• Dual mandate (full employment and stable prices)
• Quantitative Tightening (QT) and Mortgage-Backed Securities (MBS)
• Market expectations and pricing of rate cuts

1. Fed Independence and Political Influence

• The discussion begins with the question of whether external influences, particularly political pressure, affect the Fed's rate-making and policy decisions.
• Ben Emmons acknowledges that outside influence could impact the Fed. He notes that the market is focused on whether the Fed will cut rates, by how much, and whether any political influence will lead to mistimed cuts.
• The hypothetical scenario is raised: if the President wants rate cuts and the Fed is perceived as targeting one of its own (Lisa Cook), could the Fed withhold rate cuts as a form of resistance, even if the data supports a cut? This is framed as potentially "politicizing the Fed."

2. The Importance of Labor Data and the Dual Mandate

• The conversation emphasizes the significance of upcoming payroll data in shaping the Fed's decision-making process.
• A strong payroll number could give the Fed a reason to hold off on rate cuts, suggesting that the labor market isn't as weak as previously thought.
• The discussion highlights the Fed's dual mandate: full employment and stable prices. The question is raised whether full employment has taken precedence over stable pricing in the Fed's considerations.
• Emmons points out that recent inflation data appears "stickier" and "hotter," particularly in the super core, which has accelerated since April. This makes the labor data even more critical.

3. Market Expectations and the Likelihood of a Rate Cut

• The market is largely pricing in a rate cut at the September 17th meeting.
• Emmons estimates that the market believes there is an 85% chance of a rate cut.
• He suggests that only a very strong payroll report (e.g., 300,000-400,000 jobs with positive revisions) could cause the Fed and the market to change their minds.
• If the Fed does cut rates in September, the subsequent data releases in October will be crucial in determining the future path of monetary policy. Strong data could introduce volatility.

4. Quantitative Tightening and Mortgage-Backed Securities

• The discussion shifts to the Fed's balance sheet and the ongoing quantitative tightening (QT) process.
• The Fed is still allowing $35 billion of mortgage-backed securities (MBS) to roll off each month, which puts upward pressure on the 10-year Treasury yield and, consequently, mortgage rates.
• Emmons predicts that the Fed will decide to phase out the MBS roll-off at the upcoming meeting. This is because cutting rates while simultaneously tightening through MBS roll-off would be counterproductive, especially if the issue is related to the mortgage market.
• Quantitative tightening is described as "passive tightening" that operates in the background.

5. Fed Funds Rate vs. Quantitative Tightening

• The question is posed whether quantitative tightening is more important than the fed funds target rate.
• The response indicates that QT is a background factor.

6. Conclusion

• The main takeaways are that the Fed's decision on rate cuts hinges significantly on upcoming labor data, particularly the payroll report. While the market expects a rate cut in September, a strong jobs number could change the Fed's course. The Fed is also expected to address the MBS roll-off as part of its quantitative tightening policy. The potential for political influence on the Fed's decisions is acknowledged, but the data will likely be the primary driver.