Goldman Sachs adjusted its forecast for the Federal Reserve's first rate cut, pushing it back from July to September.

The revision comes as recent data and comments from Fed officials indicate that a July cut would require significant improvements in inflation and noticeable signs of weakening in activity or labor market data. Neither of which seems imminent following stronger-than-expected economic data.

"After the stronger May PMIs and lower jobless claims, this does not look like the most likely outcome," Goldman Sachs economist David Mericle wrote.

Chair Powell's Middle-of-the-Road Path

Chair Jerome Powell's recent remarks suggest a cautious and gradual approach to rate cuts. Powell acknowledges the "considerable cumulative progress made in solving the inflation problem" but also recognizes that inflation is still expected to be above target this year.

Mericle interprets Powell's comments as indicating a "middle-of-the-road path of cutting gradually."

Factors Influencing the Timing of the Rate Cut

The economist outlines three primary reasons why the timing of the first rate cut remains uncertain:

  • Optional nature of rate cuts: The perceived necessity for rate cuts is low, reducing the urgency for immediate action.
  • Improving but Imperfect Inflation: While inflation is likely to show significant improvement by September, it will still be elevated on a year-on-year basis, complicating the decision to cut rates.
  • Diverse opinions within the FOMC: While Fed leadership may be inclined towards a rate cut soon, some Federal Open Market Committee (FOMC) members remain focused on inflation concerns and are more hesitant to reduce rates.
From now until the September meeting, two additional CPI reports will be released. They will provide a total of four new data points for the Fed to consider.

Goldman Sachs predicts monthly core CPI inflation to average in the high 20s and core PCE inflation in the low 20s during this period.

"If our forecasts are roughly right, then we think most FOMC participants will support a rate cut in September," Mericle noted.

There are signs of moderate softness in activity and labor market data. Fed officials may also be wary of potential financial instability, akin to the recent crises in British pension funds and U.S. regional banks, arising from the sharp rate hikes.

The varied perspectives among FOMC participants add to the uncertainty. While some share Goldman Sachs' more relaxed outlook on inflation and support a near-term rate cut, others remain more cautious.

The latest minutes from the May FOMC meeting revealed that several FOMC members expressed uncertainty about achieving the 2% inflation target, while various participants expressed a willingness to tighten policy further should risks to the outlook materialize.

Currently, market-implied interest rate expectations indicate that traders are pricing in 34 basis points of rate cuts (one move only) by the end of year.

The chances of a September rate cut are currently a coin flip, according to CME Group FedWatch tool.