A series of interest rate hikes that the Federal Reserve launched in March 2022 has started to make an impact in slowing the US economy, making a rate cut in September more likely.

The Federal Open Market Committee will announce its latest monetary policy at the end of a two-day meeting on Wednesday, July 31 (early Thursday, August 1, in Hong Kong), with some analysts saying there is a slim chance that the US central bank may announce the first interest rate cut since March 2020. However, the more popular view is that the Fed is likely to hold off announcing a rate cut until September as it awaits more solid inflation rate data.

Meanwhile, Japan’s central bank has raised its benchmark interest rate to 0.25% from a previous range of 0% to 0.1%, marking the highest interest rates for the country since October 2008, when it was set at 0.3%.

The Bank of Japan (BOJ) also announced that it will reduce the monthly outright purchase of Japanese government bonds to about 3 trillion yen (US$19.64 billion), from the current 6 trillion yen, as of January-March 2026.

Above recession territory

In the United States, signs that the economy is slowing have emerged as credit growth and consumer spending weaken. This should continue in the second half of 2024 with headline real GDP growth materially decelerating, though clearly remaining well above recession territory, according to the latest report issued by Fitch Ratings.

“US rate rises in 2023 have begun to show some effect on the labour market and demand, while politics remains an area of high uncertainty, and geopolitical risk is here to stay,” the rating agency says. “While we now expect a slightly slower pace of rate cuts in 2024 from the Federal Reserve than our expectations at end-2023, the latest US inflation and labour market data support our view that two reductions are likely in 2H24.”

Faced with rising inflation, the Fed started its aggressive rate hikes in March 2022, which continued until July last year, bringing the federal funds rate to a target range of 5.00% - 5.25%.       

Fitch’s latest forecast is consistent with the trend experienced in Q1 2024 when US GDP growth slowed sharply to a 1.6% annual pace amid high interest rates. But at the time there were concerns that strong consumer spending may push economic growth and trigger higher inflation.

But continued disinflation and the beginning of a global monetary policy pivot have reduced the probability of a major negative credit risk scenario stemming from continued monetary tightening.

“The [European Central Bank] made its first rate cut in early June, following earlier moves by the Swiss National Bank and Bank of Canada, with the latter cutting for the second time in late July,” says Fitch, suggesting that it is time for the US Fed to do the same, a view that is echoed by other experts.

Once bitten, twice shy

Erik Weisman, chief economist of MFS Investment Management, says: “Despite a small but vocal chorus calling for the Fed to begin its loosening campaign in July, the Fed is likely to view this upcoming meeting as setting the table for its first cut in September.”

Although Weisman agrees with Fitch that the US economy is slowing down, he warns that this may not yet be a long-term trend.

“While the labour market shows clear signs of normalizing and the latest set of consumer inflation data have been relatively benign, the central bank has been encouraged by the macro data several times over the last 18 months, only to subsequently find that the economy was persistently running too hot,” he asserts. “Therefore, the Fed will likely argue that it is only prudent to observe the following six weeks of data to clearly validate the view that loosening policy is justified.”

Former World Bank treasury officer Roger Silk argues that there is be a slim chance the Fed may announce a rate cut tomorrow.

"The overwhelming majority of the market expects the Fed to cut rates between now and next year. We know this because the Chicago Mercantile Exchange (CME) – the home of most interest rate futures contracts – uses futures prices to calculate the market’s expectations of future interest rates,” Silk says.

“And the market believes that by the September meeting, it is virtually certain that the Fed will cut rates. The majority of the expectation is for a 25-basis-point cut.”

Balancing inflation and growth

Analysts also welcomed the latest move by the Japanese central bank, seeing it as a signal that the BOJ is attempting to balance controlling inflation with economic growth.

“Despite the subdued domestic private consumption recovery, the BOJ is still prioritizing taming inflation and highlighted that real rates are still significantly negative after the change in policy rate, and accommodative financial conditions should continue to firmly support economic activity,” says Peiqian Liu, Asia economist at Fidelity International.

“More importantly, the language in the communique was quite bullish on prices. The BoJ officials said that ‘underlying CPI inflation is expected to increase gradually, since it is projected that the output gap will improve and that medium- to long-term inflation expectations will rise with a virtuous cycle between wages and prices continuing to intensify,’” says Ipek Ozkardeskaya, senior analyst at Swissquote Bank.

Earlier, Magdalene Teo, of Fixed Income Research Asia, Julius Baer, said the market was increasingly pricing a BoJ rate hike, although investors were still hoping for another dovish surprise from the BoJ governor.

The term "dovish" in this context would refer to the BOJ being more focused on supporting economic growth and employment rather than primarily prioritizing price stability or low inflation.