News Highlights

  • U.S. retail sales unexpectedly rose 0.1% in August, data from the Commerce Department showed on Tuesday, underscoring strong consumer spending at a time when Federal Reserve policymakers are considering whether to cut their key interest rate by 25 or 50 basis points.
  • Most of the 13 categories covered in the report declined, including clothing, gasoline, furniture, and electronics,the Commerce Department said. However, e-commerce sales rose 1.4%, and sales at personal care, building materials, and garden supply stores also increased.
  • "This is a decent report, and FOMC participants may view it as an additional reason to cut rates by 25 basis points tomorrow," Samuel Tombs, chief U.S. economist at Pantheon Macroeconomics, said in a note to clients.

In-Depth Analysis

Despite the better-than-expected retail sales data, according to theCME FedWatch tool, interest rate futures traders on Wednesday raised the probability of a 50-basis-point Fed rate cut over a 25-basis-point move.

On Tuesday, traders saw a 63% chance of a 50-basis-point Fed cut, up from 62% on Monday, and a 37% chance of a 25-basis-point cut, with the current federal funds rate target range at 5.25% to 5.5%.

At the end of the Fed's two-day meeting on Wednesday, forecasts on the magnitude of policy easing have split economists and Wall Street analysts into two camps.

"The bottom line is that the market is unusually uncertain about the September FOMC meeting," BofA Securities analysts said in a client note on Monday.

Moody's Investors Service on Monday predicted a 50-basis-point cut, noting that "labor market data and underlying inflation indicators have for some time met the criteria for the FOMC to begin cutting rates."

"Indeed, the rapidly cooling labor market suggests the Fed is falling behind on the maximum employment side of its dual mandate," Moody's said, forecasting 75 basis points of federal funds rate cuts this year and another 125 basis points next year.

The unemployment rate rose to 4.2% from 4.2% last month (note: as per the original text, but based on context it should be "rose to 4.2%", yet the actual data compares 4.2% with 3.4%, so the original logic is retained here), while it was 3.4% in April 2023, as the labor force expanded and companies slowed hiring.

Meanwhile, inflation fell to 2.5% in August from a 9.1% annual rate in June 2022, under the Fed's most aggressive tightening in four decades.

"U.S. inflation data has been slightly stronger recently," BofA Securities analysts said in a client note, predicting a 25-basis-point cut on Wednesday and cumulative cuts of 200 basis points by the end of 2025.

At Wednesday's post-meeting press conference, Fed Chair Jerome Powell "will likely sound dovish and should emphasize downside risks to the labor market and a willingness to accelerate the pace of cuts if necessary," BofA said.

"We expect Chair Powell to reiterate the Fed's optimistic baseline scenario while acknowledging growing downside risks to the labor market," BofA said.

In June projections, central bank officials' median estimate was to lower the federal funds rate to 5.1% by the end of this year and cut it by 1 percentage point annually in 2025 and 2026.

"These projections may be revised down, especially for 2024 and 2025," Ed Yardeni, president of Yardeni Research, predicted in a research note to clients on Monday. He expects policymakers to cut rates by 25 basis points on Wednesday.

The central bank does not need to rush to cut rates, said Scott Helfstein, head of investment strategy at Global X. He predicts a 25-basis-point cut while acknowledging market expectations for double that amount.

"This is the first time in 30 years the Fed has started a rate-cutting cycle without a financial or liquidity crisis," he said in an email on Tuesday. "The economic backdrop is good, and they can take their time."