The three-sided competition pitting the White House against the Fed, bond market
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Inflation is running above the Federal Reserve's 2% target, consumers are still spending, the labor market is slowing — all dividing economists over whether to cut interest rates. But it's not stopping investors from pricing cuts in.
Why it matters: The Fed, the White House and the financial markets all hope to control interest rates. Investors may have the upper hand.
By the numbers: Investors are pricing in an over 88% chance of a quarter-point rate cut at the Fed's September meeting.
- Between now and April 2026, investors are pricing in four quarter-point cuts.
Zoom in: The bets on lower rates come despite evidence pointing to higher inflation, including:
- A Producer Price Index reading that came in well above consensus estimates, indicating higher prices have been driven in part by tariff policy.
- The core reading within the Consumer Price Index, the Fed's preferred inflation gauge, came in at over 3% from a year ago, above the Fed's 2% inflation target.
- That's a difficult environment to lower rates, but Fed policymakers could put forward an "insurance cut," Joe Brusuelas, chief economist at RSM US, tells Axios.
- Any further cracks in the labor market could help justify that as well.
Situational awareness: It wouldn't be the first time the central bank cut rates while inflation ran above its target.
- The Fed pause of 2022 that led to a subsequent half-point cut in rates was driven in part by "large and increasingly optimistic speculation on Fed posture," according to a note from Bank of America.
What they're saying: "It's a three-sided competition pitting the Fed, White House and bond market against each other to determine the direction of the economy," Brusuelas says.
- The bond market is sleepy right now, in part because many traders are on summer vacation.
- Fixed-income investors will wake up as we get closer to the fall, and the September meeting of Fed policymakers.
Zoom out: If the Fed cuts in 2025, it would " likely take place amid a backdrop of rising year-over-year inflation," BofA notes.
- That could lead to a weaker dollar, which also followed rate cuts amid higher inflation in the 1970s.
- The yield curve could also steepen as investors price in higher long-term rates to fight the inflationary backdrop.
What we're watching: If the Fed yields to pressure from markets or the White House with a rate cut, the bond market will likely be the ultimate judge of whether the central bank made the right call.
- As Fabio Natalucci, former deputy director of the International Monetary Fund told Axios this week, the bond market "will price [any] policy mistake."
