| Good morning. The Fed signals a cut may come in September and Meta's earnings indicate AI investments are paying off. Here's what's moving markets. — Sam Unsted Want to receive this newsletter in Spanish? Sign up to get the Five Things: Spanish Edition newsletter. The Federal Reserve kept interest rates on hold as expected, but signaled cuts are getting closer unless progress stalls on getting inflation back to target. Chair Jerome Powell said policymakers will keep watching the data closely, but that if everything keeps moving in the direction it is now, then "a reduction in our policy rate could be on the table as soon as the next meeting in September." US stock futures are edging higher, Treasuries are lower and the dollar is up as the Fed decision reverberates, complemented by earnings from the tech sector. The yen is flat, but a furious run for the Japanese currency after its central bank hiked interest rates has set up a new target for traders. The Bank of England is due to make its rate decision later, with wagers tilted toward a cut. Facebook and Instagram parent Meta Platforms is rising in premarket trading after its results indicated that AI investments are paying off by driving sales of more targeted advertising. That comes after a disappointment from Microsoft, but also follows a surge for US tech stocks on Wednesday, led by Nvidia adding $329 billion in market value. Fellow trillion-dollar club members Apple and Amazon will report after the close. Beyond Nvidia, the picture in the chip sector is less rosy. Qualcomm initially rallied after its results but that fizzled amid worries of a slow recovery in the smartphone sector. Chip designer Arm Holdings slid after it stuck to a tepid forecast, with no sign it will replicate the AI-related boom seen at Nvidia or Broadcom. For the broader market, the US is considering unilateral restrictions on China's access to AI memory chips and equipment as soon as next month. Oil prices have extended their gain following a jump on Wednesday amid ongoing concerns about escalating tensions in the Middle East. The extra bounce, which has seen Brent settle above $80 a barrel, came following a report that Iran had ordered a retaliatory strike on Israel for the killing of a Hamas leader on its soil. Oil traders are loading up on call options following this week's price spike on the possibility the rise will continue. There is a hot debate on Wall Street over whether high interest rates have a cooling or stimulating impact on the economy. Once the Fed starts cutting the benchmark rates, will that make you richer or poorer? Share your views in Bloomberg's latest MLIV Pulse survey. This is what's caught our eye over the past 24 hours. The expectation going into the Fed rate decision yesterday was that Powell & Co would set up September as the start of the cutting cycle. That didn't exactly happen. The door is certainly wide open for September and Chairman Powell certainly said it's a live possibility, but he didn't tee it up. He didn't say it's a slam dunk.
He also said it was possible that rate cuts aren't coming at all, depending on how the data evolves. Quite simply, the Fed is still not completely confident that inflation is returning to target. And while the Fed certainly is paying attention to the evident softening in the labor market (as seen in a host of indicators), from their perspective, this softening could still be just "normalization", rather than something worse (the early innings of a recession). Now before going any further, it's worth noting here that the market still sees a September cut as a lock. In fact, per the WIRP function on the terminal, the market is pricing a bit more than a 25 basis point rate cut in September. In other words, there's a small chance they go for 50. So the market still thinks the cut(s) are coming imminently, even if Powell wasn't ready to just come out and say it. One of the criticisms towards the Fed is that a commitment to "data dependency" (which is a term you've probably heard a lot over the last decade) creates the risk of reactive policy, rather than proactive policy. In other words, you might have a model of the world where inflation is set to cool (based on various factors), but if you're waiting around to see proof that you've achieved victory, then you run the risk of acting too late. So in this specific moment, there are theoretical reasons to think inflation will return to target. We've seen this increase in the unemployment rate. We've seen the deceleration in wages (just yesterday we got news that the Q2 Employment Cost Index grew at just 0.9% vs. expectations of 1%.) We've seen the fall in the Quits Rate. Multiple indicators point to ongoing slackening. We've also seen inflation measures themselves trend lower, including the start of a long-awaited deceleration in various measures of shelter costs. Meanwhile, Fed officials themselves have characterized the current stance of policy as being "restrictive" (meaning it should be putting downward pressure on inflation.) In theory, inflation should continue to trend lower. But if you take data dependency in its strongest form, then it's not about what's true in theory, it's about what's true in reality. And what's true in reality is that the Fed doesn't see inflation having fully resolved itself, and so it's inclined to wait a little bit longer for more confirmation of it all working out. Reading through the transcript, what strikes me as interesting is that the Fed wants to see more evidence of inflation cooling (softer inflation data prints) but it doesn't want to see the labor market getting weaker. Here was an exchange between Powell and AP reporter Chris Rugaber: QUESTION: You mentioned not wanting to see any further cooling in the job market. Why not? Or would you consider preemptive cuts to prevent if you saw risks of an unexpected cooling, is that something you would cut ahead of time for? POWELL: So, I wouldn't say I wouldn't want to see any other cooling. It would be more of a material difference. We'd be looking at this, and if we see something that looks like a more significant downturn, that would be something that we would have the intention of responding to. So, in terms of, I don't think of it that way. I think of it as we're actually in a good place here. We're balancing these two risks of go too soon and you undermine progress on inflation, wait too long, or don't go fast enough, and you put at risk the recovery. And so, we have to balance those two things. That's the nature of having two mandates, and I think we -- this is how we balance them. It's a rough balance, but it does feel like, again, the labor market feels like it's in a place where it's just a process of ongoing normalization. 4.1% unemployment is still historically low, and we'll just have to see what the data show us.
There's something else interesting here in that last paragraph. Powell talks about 4.1% unemployment being "historically low" which is definitely true. Labor market indicators are at robust levels. And in fact, Powell talked about how other labor market indicators (like quits, hires, wages etc.) are around 2019 levels, which wasn't an inflationary environment. But levels are one thing and direction of travel is another. The levels may be 2019-like, but the direction of things are not. 2019 was a year of general improvement (unemployment fell from 3.8% to 3.6% that year.) So far 2024 has been a year of labor market softening. So the levels may be roughly comparable to 2019, but the direction is not. Tomorrow we get the latest version of the Non-Farm Payrolls report and the expectation is that the U3 Unemployment holds steady at 4.1%. But the question is whether labor market conditions are softening faster than the Fed appreciates, and whether the Fed (in its current data-dependent mindset) is capable of getting ahead of the curve in such a way to stem the further softening that Powell says he doesn't want to see. Follow Bloomberg's Joe Weisenthal on X @TheStalwart | 
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