What would it take for the Fed pricing to move from two rate cuts to three next?

If you want to be simplistic about it, the US CPI report yesterday is not one to suggest that inflation is heading back towards the 2% target this year. But if you go into the details, the core components does at least suggest that things are trending in the right direction; albeit very slowly.

That being said, other parts of the US economy are perhaps starting to show signs of slowing down. The jobs market is beginning to ease and we saw a bit of a setback in the US consumer from the retail sales data yesterday. The question now is, will a continuation in those developments urge the Fed to cut rates sooner rather than later?

Well, for one, it at least dispels any notion of returning to rate hikes. Secondly, it certainly doesn’t hurt the argument of having the Fed become more dovish as the economy slows.

But perhaps the more important thing to note is that the Fed might have the appetite to stomach a slowing economy, as their focus remains on ensuring inflation gets back to target. That is despite their supposed dual mandate.

I mean, the worst thing for the Fed now will be to see the disinflation process stall. And that will start to bring about whispers of stagflation risks. It would be something Powell surely hopes to avoid in the months ahead.

But as markets are now looking to two rate cuts this year at least, is there any chance we get to see three come into the picture?

It’s going to be a tight one, if that so happens to be the case.

Any move in June or July can likely be ruled out as it is still too soon to call with much certainty that the Fed is on top of the battle against inflation right now.

Besides, the next US CPI report is only due out the same day as the next FOMC meeting decision on 12 June. That arguably rules out a move there. As for July, I think we’ll also have to see a perfect streak of weaker inflation and a slowing economy for that to even be in consideration. But for now, traders are still seeing a ~38% probability of a rate cut in the summer.

Putting aside those two dates, that leaves us with just three more meetings for the year. That being in September, November, and December.

Similar for how conditions might line up for an improbable July move, it would require inflation to be consistently trending lower in the next few months first and foremost. And at the same time, softer economic data in general will also help to develop the narrative.

But if things hold as they are now and inflation ends up closer to 3% than 2% by August, I don’t see how markets are going to consider a potential for a third rate cut. In fact, a second rate cut might also be in question in such a scenario.

As such, it is arguably a tall order to price that in any time soon. But when the Fed does pivot, I reckon we can see traders move to price in more rate cuts rather quickly. That unless the Fed manages expectations well in signaling a one-and-done move to start things off, just like how the ECB is doing now.

For broader markets, the argument in bold is perhaps what might take the punchbowl away from the ongoing party.

This article was written by Justin Low at www.forexlive.com.