Podcast Summary: "Higher Bar for September Rate Cut"

Podcast Information:

• Title: Thoughts on the Market
• Host/Author: Morgan Stanley
• Description: Short, thoughtful, and regular takes on recent events in the markets from a variety of perspectives and voices within Morgan Stanley.
• Episode: Higher Bar for September Rate Cut
• Release Date: August 5, 2025

1. Introduction to the FOMC Meeting

The episode opens with Matthew Hornbach, Morgan Stanley’s Global Head of MacroStrategy, and Michael Gapen, Morgan Stanley’s Chief U.S. Economist, discussing the recent Federal Open Market Committee (FOMC) meeting held on August 5, 2025.

Matthew Hornbach (A):
“Today, a look back at last week's meeting of the Federal Open market committee, or FOMC...”
[00:00]

They aim to dissect the FOMC's updated policy statement and Chair Powell’s subsequent press conference, setting the stage for the episode's primary focus.

2. Tone of the Federal Reserve’s Statement

Michael Gapen provides an analysis of the FOMC’s official policy statement, highlighting its nuanced tone.

Michael Gapen (B):
“…the statement I thought took on a slightly dovish tone for two reasons.”
[00:39]

Key Points:

• Revised Economic Growth Assessment: The Fed downgraded its previous "solid pace" growth outlook, aligning with Morgan Stanley’s view that economic activity is moderating.
• Dissent within the Committee: Governors Bowman and Waller dissented in favor of a 25 basis point rate cut in the July meeting, introducing a more dovish perspective.
• Chair Powell’s Concerns: While acknowledging inflation pressures due to tariffs, Powell emphasized the resilience of the labor market, describing it as "solid and in healthy condition" with "full employment."
  [00:39]

This combination suggests a higher threshold for the Fed to consider cutting rates in September.

3. Deep Dive into the Labor Market

Matthew Hornbach probes deeper into the labor market analysis, reflecting both his and Gapen’s viewpoints.

Matthew Hornbach (A):
“If we could dig a little bit deeper on that point... channeling your views on the labor market.”
[02:22]

Michael Gapen (B):
“Our thesis... immigration controls have really slowed growth in the labor force... have come down the break even rate of employment.”
[02:48]

Key Insights:

• Impact of Immigration Controls: Slowed labor force growth has reduced the break-even employment rate, meaning even with slower economic and employment growth, unemployment remains low.
• Contrary to Traditional Indicators: Typically, slower employment growth signals economic downturn and potential for rate cuts. However, due to a contracting labor force, low unemployment persists, indicating a tight labor market.
• Policy Implications: Continual immigration restrictions may sustain low unemployment despite weak job growth, complicating the Fed’s decision-making process regarding rate cuts.

4. Federal Reserve’s Policy Path Forward

The conversation shifts to the potential trajectory of Fed policy, especially regarding rate cuts in September.

Matthew Hornbach (A):
“How are you thinking about the Fed's policy path from here?... remaining data that could get the Fed to cut rates in September?”
[03:47]

Michael Gapen (B):
“Powell essentially is laying out a case where it's more likely than not inflation will be deviating from the 2% target...”
[04:03]

Key Points:

• Inflation Persistence: Powell indicated ongoing inflationary pressures due to tariffs impacting consumer prices.
• Labor Market Indicators: Emphasis on maintaining a low unemployment rate over mere employment growth suggests reluctance to cut rates.
• Data Dependence: The Fed will closely monitor upcoming inflation and labor market data, particularly between the July and September meetings, to inform their decision.
• Potential Outcomes:
  • Rate Cuts in September: If data shows the labor market is weakening significantly.
  • No Rate Cuts: If the labor market remains tight, leading the Fed to maintain current rates into early 2026.

5. Market Reaction to the FOMC Meeting

Matthew Hornbach discusses how the market has responded to the FOMC's latest moves and statements.

Matthew Hornbach (A):
“We saw the market take out some probability that the Fed would lower rates in September... about a 50% probability on a rate cut.”
[05:52]

Key Insights:

• Initial Reaction: The dovish tone of the statement initially increased expectations for a potential rate cut.
• Shift After Powell’s Press Conference: Powell’s hawkish remarks on inflation and labor market stability reduced the probability of a September rate cut to around 50%.
• Data Dependence: The market remains uncertain, awaiting further data to better price the Fed’s policy path.
• Future Implications: Decisions made in September are crucial for shaping market expectations for policy evolution in the latter part of the year.

6. Term Premium and Treasury Yields Analysis

The discussion transitions to term premiums and their influence on Treasury yields, drawing on recent events and market dynamics.

Michael Gapen (B):
“We’re still thinking the lagged effects of tariffs and immigration will slow the economy enough to get more Fed cuts than the market's thinking.”
[07:42]

Matthew Hornbach (A):
“…term premia in the treasury market... treasury yields went up relative to what people were thinking about the path of Fed policy.”
[08:22]

Key Points:

• Term Premium Expansion: Triggered by the April 2nd Liberation Day event, leading to higher Treasury yields.
• Diminished Trade Policy Risks: As trade deals have been announced, the initial trade-related risks have lessened, stabilizing Treasury yields.
• Supply Concerns: Previously, concerns about U.S. Treasury supply influenced term premiums, but recent announcements indicate no significant increase in supply until early 2027, reducing uncertainty.
• Investor Behavior: Increased comfort with duration risk as Treasury supply uncertainty diminishes.

7. Future Outlook and Upcoming Events

Closing the episode, Hornbach and Gapen outline future expectations and key events to watch.

Matthew Hornbach (A):
“We will have an update to those tariff revenues... the Economic Symposium in Jackson Hole where Chair Powell will give us his updated thoughts.”
[09:57]

Key Takeaways:

• Tariff Revenue Updates: Ongoing monitoring of tariff revenues, which are substantial and influence Treasury supply dynamics.
• Jackson Hole Symposium: A pivotal event where Chair Powell is expected to provide updated insights on economic and monetary policy outlooks.
• Market Expectations for 2026: Gapen suggests that the Fed may undertake around 175 basis points of rate cuts in 2026, a view the market hasn’t fully priced in yet.

Conclusion

In this episode of "Thoughts on the Market," Matthew Hornbach and Michael Gapen provide a comprehensive analysis of the recent FOMC meeting, highlighting the nuanced stance of the Federal Reserve amidst evolving economic indicators. The discussion underscores the complexity of the current labor market dynamics, influenced by immigration controls and sustained low unemployment, which collectively pose a higher threshold for potential rate cuts in September. Additionally, the conversation delves into the intricacies of term premiums and Treasury yields, offering insights into investor behavior and market adjustments. As the economic landscape continues to evolve, key events such as tariff revenue updates and the upcoming Jackson Hole Symposium will be critical in shaping future monetary policy and market expectations.

Notable Quotes:

• Michael Gapen (B):
  “…the combination of that suggests it's a higher bar in our mind for the Fed to cut in September.”
  [02:22]

• Matthew Hornbach (A):
  “The market is still some distance away from your view that the Fed goes about 175 basis points in 2026.”
  [07:42]

• Michael Gapen (B):
  “If the Fed's doing its job, this shouldn't be magic. If the labor market's obviously rolling over, you'll get cuts later this year.”
  [04:03]

This structured and detailed summary encapsulates the key discussions, insights, and conclusions from the "Higher Bar for September Rate Cut" episode, providing a comprehensive overview for those who have not listened to the full podcast.