Keep an eye on the Fed this week

This week's main event is the Federal Reserve's September meeting, where the central bank is widely expected to deliver its first rate cut. Despite the Fed chair's dovish tone in Jackson Hole, markets had placed the probability of a 50-basis-point rate cut in September at just 30%. Now, that probability has shifted to a toss-up. Traders expect the fed funds rate to fall by 125 basis points by the end of the year. That 's an additional 50 basis points lower than the FOMC's median forecast for the end of this year.

With employment growth slowing, economic growth is also expected to decelerate. Households are likely to save a larger share of their income as concerns about job security and future consumption grow. As households attempt to smooth their consumption over time, current spending is expected to decline. Businesses, facing reduced consumer demand, may cut output and potentially lay off their least productive workers — at least, that's how the scenario typically unfolds.

However, despite downward employment growth revisions, the U.S. economy remains in good shape, and the labor market is more balanced. The share of prime working-age individuals who are employed is at a 23-year high, with no sign of slowing. The unemployment rate is still low at 4.2%, and the four-week moving average of initial unemployment claims — a leading indicator — remains at roughly 231,000, lower than the average for the late part of the cycle in any economic expansion of the past 60 years. The Federal Reserve Bank of Atlanta's GDPNow estimate for real GDP growth (seasonally adjusted annual rate) in the third quarter of 2024 increased to 2.5% on Sept. 9, up from 2.1% the previous week. Real wages have also continued to rise as inflation eased.

In addition to the Fed's interest rate decision, data on retail and home sales are expected to provide further insights into the state of the consumer. Retail sales were stronger than expected in July and are likely to surprise on the upside again. While consensus expectations suggest existing home sales will decline, the significant improvement in housing affordability, partly due to falling mortgage rates, may result in a less pronounced seasonal slowdown in housing activity, with sales potentially ending higher than in 2023.

My best guess: the normalization of the yield curve will continue. While short-term rates will fall slowly along with gradual Fed rate cuts, longer-term rates should remain anchored near current levels. Expect more volatility during this adjustment process.

— The Center Square