Fed Rate Hike Unlikely Amid Cooling Inflation and Stronger Economic Growth

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The Federal Reserve's rate-setting committee is set to meet on Tuesday and Wednesday this week, with the central bank's economic projections expected to reflect cooler underlying inflation and stronger economic growth. The changes in these key indicators suggest that the Fed is unlikely to raise interest rates in the near future.

In their June meeting, the Fed projected that their preferred measure of consumer prices would be 3.2% higher in the fourth quarter of this year compared to a year earlier. They also forecasted a 3.9% increase in core prices, which exclude food and energy items. However, recent estimates by Morgan Stanley economists indicate that core prices will only be up 3.3% in the fourth quarter from a year earlier, with other forecasts from Goldman Sachs and JPMorgan Chase (NYSE:JPM) also falling below the Fed's original projection at a 3.4% gain.

This decline in inflation forecasts is a significant factor in why a rate increase at this week's meeting seems highly improbable. While the Fed's updated projections will likely still show one last quarter-percentage-point hike to the central bank's target range on interest rates by the end of the year, this could be seen more as policymakers retaining their option to hike, rather than a definite plan.

Furthermore, the economy has shown more strength than previously anticipated by policymakers. The Fed's June projections showed a median forecast of just 1% growth in gross domestic product (GDP) in inflation-adjusted terms in the fourth quarter from a year earlier. However, economists polled by S&P Global Market Intelligence last week estimate that GDP will be up by 1.8% in the fourth quarter. This resilience might lead policymakers to conclude that the economy is handling their rate increases better than they had expected.

In other news, there are rumors about a potential face-to-face meeting between US President Biden and China’s President Xi. However, markets are unlikely to be significantly impacted by this development due to the ongoing economic nationalism trend globally. Also, the Trump administration’s tariffs on US consumers of Chinese goods remain in place.

Moreover, oil prices continue to be a focal point for investors, with Brent crude still over USD90 per barrel. This is a stark contrast to the situation at the start of the war in Ukraine in 2022 when consumers in the US and Europe were able to transfer pandemic-era savings to oil producers to meet higher prices without cutting non-oil consumption. With savings now depleted, higher oil prices today are more likely to be growth deflationary.

Finally, the US NAHB housing market index is due this week. While Fed rate hikes have not affected existing homeowners who locked in mortgage rates, new homeowners are facing higher borrowing costs, especially considering weaker consumer spending power.

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