Stocks are flying, the Dollar is falling, tariffs haven't hit yet. Why cut rates now?

Mint

a day ago

As 2025 nears its halfway point, a latter-day Rip Van Winkle who might have been napping since the start of the year might think not much had changed. The S&P 500 index, while closing at a new high on Friday, was up an unremarkable 5%.
That, of course, obscures the dramatic swings in between, with a near bear-market 19% decline from February to the lows after the Trump administration's April 2 Liberation Day tariff announcements. Then came an equally dramatic rebound following a pause in tariffs and a retreat from triple-digit levies threatened for China.
But mainly, the first half gave rise to the investment meme of 'Nothing ever happens," insofar as the stock market is concerned. Trade wars and the uncertain impact of tariffs on the economy; fiscal fights over the Big, Beautiful tax bill that resulted in the U.S. losing its last triple-A credit rating; and conflicts in the Middle East, including the U.S. bombing of Iranian nuclear sites on June 22. After all of that, the S&P 500 and the Nasdaq Composite are ending the first half at record highs.
Forget about the proverbial 'wall of worry" that bull markets supposedly ascend. The new belief, 'Nothing ever happens," is actually relevant to stocks and helped induce individual investors to buy the steep dip in April and May, putting a lie to all the hand-wringing. By halftime, the mood had swung back to FOMO, or fear of missing out.
What hasn't changed is the Federal Reserve's policy stance. And yet, despite an ebullient equity market, an accommodative credit market, and a sharply lower dollar—all signs of easy financial conditions—the president has harangued Fed Chair Jerome Powell for failing to slash its federal-funds target range, which has been held at 4.25% to 4.5% since December.
In congressional testimony this past week, Powell reiterated uncertainty about the effect on prices from tariffs, which mostly haven't hit yet. As EY-Parthenon Chief Economist Gregory Daco explains, their impact has been blunted by the front-loading of imports before the levies hit; use of bonded warehouses and foreign trade zones, which can delay tariff payments until goods enter the U.S.; temporary cost absorption by importers; lags in measuring tariff pass-throughs; and absorption of costs by exporters.
Goldman Sachs economists expect just a one-time inflation boost from tariffs, raising the year-over-year core personal consumption expenditure index (excluding food and energy) to 3.4% in December, significantly higher than the 2.7% increase in the latest 12 months for the Fed's preferred inflation gauge reported on Friday. Brean Capital economic advisors John Ryding and Conrad DeQuadros note that the most recent CFO survey, conducted by Duke University and the Richmond and Atlanta Feds, found 41% planned to hike prices while 30% said they would absorb tariff cost increases in the next year.
Goldman's inflation forecast is well above the Fed's 2% target, making it difficult to justify cutting rates now. Yet two Fed governors, Christopher Waller and Michelle Bowman, have said they would consider rate cuts if inflation is stable. The fed-funds futures market is pricing in two cuts of a one-quarter percentage point each by year end, with a 74.8% probability of the first move in September, according to the CME FedWatch site.
Given the uncertain course of tariffs and their inflation impact, the more likely spur for a rate cut would be a deterioration in the labor market. That will put the monthly jobs data to be released in the coming, holiday-shortened week in the markets' focus. The consensus guess among economists is for a 125,000 rise in nonfarm payrolls in June, down slightly from May's 139,000 increase, with the headline unemployment rate continuing to hold steady at 4.2%.
Deutsche Bank economists estimate it may take only a monthly payroll increase of 100,000 to keep the jobless rate steady, below the average gain of 124,000 in the first five months of the year, because of slower labor force growth. With no net immigration flows, only a monthly payroll rise of 60,000 would keep the unemployment rate flat. With deportations, just 40,000 payroll gains would be at break-even.
Given the surge in retirements by baby boomers, RBC Capital Markets Senior U.S. Economist Michael Reid writes that the U.S. needs more workers rather than more jobs. While the labor-force participation rate is historically low at 62.4%, for the prime working age cohort it's near a record high of 83%. Retirees, meanwhile, provide a spending tailwind out of their savings and accumulated wealth.
At record highs, the stock market provides support for these spenders, along with interest income that had been lacking during the zero-rate era. At the same time, credit markets attest to the financial strength of the corporate sector, writes John E. Silvia, the former chief economist at Wells Fargo.
Along with tight corporate bond spreads, the S&P 500's record close indicates easy financial conditions. In particular, new highs in banks and financials point in the same direction. The one big change since the beginning of the year has been the dollar, which has declined by a sharp 10%, yet another easing in overall financial conditions. All of which makes calls for Fed rate cuts puzzling.
Write to Randall W. Forsyth at [e-mail]