Investors still harbour hope of Fed’s Powell giving a rate-cut the thumbs up

THE S&P 500 plunged into a bear market in April, then staged an epic recovery, and now the US Federal Reserve will reveal which was the correct response.

The central bank is likely to leave rates unchanged at the current level between 4.25 per cent and 4.5 per cent at the end of its two-day meeting on Thursday (May 7, Singapore time). There’s now a chance, however, that Fed chairman Jerome Powell will telegraph a pivot to rate-cutting later this year. It’s a chance that the stock bulls are counting on.

Solita Marcelli, chief investment officer (Americas) of UBS, wrote in a note to clients: “Markets are now factoring in both a Trump and a Federal Reserve ‘put’, in line with our base case that tariffs will be reduced from current announced levels over the remainder of the year and that the Fed will cut interest rates further in 2025.”

Until mid-April, such a pivot was out of the question. Two of the biggest sell-offs of the month were related to this fact.

First, on Apr 16, Powell warned that conditions would have to change significantly for a rate cut to be appropriate. Five days later, stocks plunged after President Donald Trump threatened to fire the Fed chair for not cutting rates.

Despite Trump’s later denial that he would ever fire Powell, the president’s insertion into the central-bank debate seemed to place Powell in an impossible position. On Sunday, Trump reiterated that he won’t remove Powell before his term ends in May 2026, even though he described the central banker as a “total stiff” and repeated calls for the Fed to lower rates.

To put it simply, how could the Fed change policy without giving the appearance that it was bowing to Trump’s pressure, and thus compromising the independence that has made it the only trusted backstop of global markets?

But economic data and corporate commentary has now fulfilled some of the conditions that Powell has long anticipated. First-quarter gross-domestic product shrank by 0.3 per cent.

More significantly, for the central bank’s dual mandate, private employers added surprisingly few workers during April, a mere 62,000. April jobs data from the Labor Department was stronger, but weekly data suggests layoffs are picking up.

On the inflation front, the Fed’s preferred measure of consumer prices, the personal consumption expenditure index, was negative in March on a month-to-month basis, and up only 2.3 per cent on an annual basis.

In normal times, that would be close enough to the Fed’s 2 per cent target to constitute conditions for a cut. That’s why stocks took flight as May arrived.

But these are not normal times. The Fed’s hands could be tied, at least in the short term, by two concerns.

The first is tariffs. More specifically, the Fed and many other economists have raised concerns about the likelihood of consumer price increases caused by tariffs.

A host of companies, including the likes of Amazon and consumer goods giant Kimberly-Clark, have warned they are anticipating higher costs. Inflation expectations among consumers and corporations are picking up – one of the main reasons that consumer confidence has fallen to multiyear lows in recent surveys.

The second reason is the challenge to the Fed’s independence.

The public pressure from Trump to cut rates has created a moral hazard for the Fed, according to economists at Bank of America Global Research. Even if the voting committee were inclined to get ahead of the curve by cutting rates, they might now refrain to exert their independence.

The “Fed put” may not be forthcoming, the Bank of America economists warned.

If Powell does not pivot, and pushes back on market expectations for a June rate cut, stocks could revisit the April turmoil. After all, the recent rebound was driven in large part by the rebound of Treasury yields.  

Strategists at money-manager Schroders bring up another long-term issue. Even if the Fed meets market expectations for a rate cut in June, followed by two more later in the year, the central bank may not be able to save the global economy from the impact of a trade war.

Most economists expect China and the US to ratchet tariffs down from their current levels, which are bordering on the absurd. The global economy, after all, revolves around Chinese exporters feeding voracious US consumers around the clock.

By some estimates, over 70 per cent of goods that Americans buy on Amazon come from China. Small businesses import billions of dollars worth of their supplies from the Middle Kingdom.

A 145 per cent levy on goods at each border would sideline millions of Chinese workers, and put thousands of American businesses into bankruptcy.

And, of course, it would drive up prices of almost every consumer good in the US. Another spike in inflation, the Schroder’s strategists noted, would stop the Fed’s rate-cutting cycle in its tracks. That’s why most Wall Street economists currently forecast only one rate cut in 2026.

“In our view, that expectation of stagflation could be increasingly plausible if uncertainty persists and tariffs slow global commerce materially,” said the Schroders strategists.

Powell stands over the US stock market with his thumb wavering, like Caesar before the defeated gladiator. Investors hope he will give the idea of a rate cut the thumbs-up.