The Big Picture
Column Summary:
*The Federal Reserve is not cutting rates soon.
*The stock market has rallied on hopes for future rate cuts and easing trade tensions, despite signs of a softening labor market.
*Both the Fed and analysts are in a wait-and-see mode, as mixed data and tariff impacts create uncertainty about the timing and likelihood of rate cuts.
The Federal Reserve is not going to cut the target range for the fed funds rate. We cannot make that statement any more definitive. Leaving it there, though, implies an element of perpetuity, and forever is a long time.
There was a time when it seemed like the Fed would never raise the target range for the fed funds rate. It remained at the zero bound from December 2008 to December 2015. That was in the aftermath of the Great Financial Crisis, which triggered the Great Recession.
The target range for the fed funds rate would return to the zero bound in March 2020 in the wake of the COVID pandemic, which one might take artistic license to call the Great Pandemic. It was not until March 2022 when the Fed voted to raise the target range for the fed funds rate off the zero bound. It did so amid some "Great Inflation" that included the PCE Price Index peaking at 7.2% in June 2022.
There was nothing truly great about any of those experiences, except perhaps the performance of the stock market, which feasted on the ultra-accommodative policy and the indelible imprint of the so-called "Fed put."
Clearly, the Fed isn't going back to the zero bound anytime soon, and perhaps never again, yet the stock market seems to be holding fast to the idea that help from the Fed is on the way. It might just get it, too, if labor market data continue to soften.
Lots of Theories, Not Enough Data
The Federal Reserve will conduct its Federal Open Market Committee (FOMC) meeting on May 6-7. The FOMC will have a lot to discuss, but it won't do anything when it comes to the target range for the fed funds rate. It will remain unchanged at 4.25-4.50% at the conclusion of that meeting. Hence, we started this week's column with the definitive statement that the Fed is not going to cut the target range for the fed funds rate.
The fed funds futures market is equally assured of the Fed standing pat, having assigned a tiny 2.6% probability to a 25-basis point cut to 4.00-4.25% at the May meeting. It has been guided to that near certainty by multiple Fed officials, including Fed Chair Powell, who have expressed a desire to wait and assess the impact of the tariff actions.
Many Fed officials are concerned that moving too soon to cut rates could exacerbate inflationary pressures, which are expected by many economists to increase in coming months. We know President Trump doesn't share that view and has called on Fed Chair Powell to cut rates now, highlighting the drop in gas prices to make his case.
Others, meanwhile, have also pointed to moderating home prices and lower airfares to strengthen the rate cut argument. Ironically, another stream of thought is that the tariff actions could be disinflationary, with higher prices sapping demand.
There are a lot of theories about what could happen because of the tariffs. There just isn't enough data yet to solidify any of the views.
Holding Steady
We are hearing a lot of companies during the first quarter earnings reporting period suggest they might raise prices or cut costs to mitigate the impact of the tariffs on their bottom line, but we aren't hearing a lot of companies ring alarm bells about the tariffs -- not yet, anyway. Some companies are saying that the tariffs have started to impact demand, but there hasn't been a universal rush to cut earnings expectations in a big way.
Since "Liberation Day" on April 2, the forward 12-month EPS estimate has come down just 0.5% to $276.40, while the calendar year 2025 EPS estimate has slipped only 1.3% to $264.54, according to FactSet.
Analysts, in general, haven't been slashing estimates, partly because the first-quarter reports are coming in much better than expected and partly because they realize so much is up for negotiation on the tariff front. Things can go from bad to worse to good again, maybe even in a single day.
Everyone, including the Fed, is playing the waiting game.
The comeback in the stock market from the April 7 low has been fueled in large part by the premonition that the news on tariffs and trade negotiations will soon have a predominantly positive tenor, but we would submit that there is a secondary consideration: the Fed cutting rates sooner rather than later.
Briefing.com Analyst Insight
With its gain on May 1, the S&P 500 logged an eight-session winning streak. It gained 8.7% over that span, which also included a slate of labor reports showing the following:
- Job openings in March hit their second-lowest level since 2020.
- Initial jobless claims -- a leading indicator -- rose above 240,000 for only the second time since July 2024.
- Private-sector payrolls increased by the smallest amount (62,000) since July 2024.
- The Employment Index for the ISM Manufacturing PMI posted its third consecutive month of contraction.
- Layoffs reached their highest total for the month of April in five years, according to Challenger, Gray & Christmas.
The April Employment Situation Report, which featured a 177,000 increase in nonfarm payrolls and a steady 4.2% unemployment rate, wasn't released during that run. It came on May 2, and it quieted some of the growth concerns that had been building on the back of the aforementioned labor reports.
It also exposed that growth concerns and the ideation that the Fed could cut rates sooner rather than later have been part of the market mix. How do we know? Treasury yields spiked after its release, and the fed funds futures market, which had been pricing in four rate cuts before the end of the year, with the next coming in June, downshifted to expect only three rate cuts and the next one coming in July.
The stock market rallied on the report, getting the best of both worlds. First, the employment report tempered recession concerns, and secondly, the report wasn't so strong as to make the market think there won't be any rate cuts this year.
Three cuts before the end of the year might be ambitious, but in any case the writing is on the wall of the fed funds futures market, and that writing doesn't spell inflation. It spells weak growth driven by weakening end demand that is a consequence of a weakening labor market. A case can be made, though, that there won't be any rate cuts if the tariffs drive up inflation like some fear they might.
The stock market and the Treasury market have not been living in fear of that lately. The S&P 500 has soared 18% off its April 7 low; meanwhile, the 2-yr note yield has dropped roughly 60 basis points from its February high while the 10-yr note yield has dropped about 30 basis points. That isn't an inflation trade. It is a trade wrapped up in growth concerns.
The rally in the stock market has been aided by an easing in trade tensions between the U.S. and most countries since the reciprocal tariff rates were put on hold. That rally, though, has also coincided with the drop in Treasury yields that has been precipitated by the specter of economic weakness stirring in the data and specifically in the softening labor market data.
The more things stir there, the higher the likelihood there is that the Fed will cut rates. The stock market expects as much, which is partly why it managed to look through a spate of softening labor market data leading up to the April employment report.
