Fed Should Cut 5.5% Rate as Restrictive Stance Adds to Inflation, Democrats Say

Key Takeaway

• Democrat senators urge the Fed to cut the federal funds rate from 5.5%, citing economic slowdown and rising costs in housing, construction, and auto insurance.
• Financial markets now expect a first 25 basis-point rate cut in September instead of July due to a resilient labor market.
• The senators suggest following the ECB's lead by moving away from the 2% inflation target, warning that divergence could tighten financial conditions further.

Senators Urge Fed to Cut Rates

Three Democrat senators, Elizabeth Warren (D-Mass.), Jacky Rosen (D-Nev.), and John Hickenlooper (D-Colo.), have called on the Federal Reserve to reduce the federal funds rate from its current 5.5%, a two-decade high. In a letter to Fed Chairman Jerome Powell, the senators argued that the prolonged period of high interest rates is slowing the economy and failing to address the remaining key drivers of inflation. They highlighted that the elevated rates are increasing costs in housing, construction, and auto insurance, potentially pushing the economy into a recession and causing job losses. The senators suggested that the Fed should follow the European Central Bank's lead and move away from the 2% inflation target, noting that the ECB and the Bank of Canada recently cut rates.

Market Reactions and Divergence

The resilient labor market has led financial markets to push out expectations for a 25 basis-point rate cut to September from July. This hawkish repricing has stalled a rally in bitcoin (BTC). Singapore-based crypto trading firm QCP Capital views the drop in BTC and ether (ETH) prices as a buying opportunity, anticipating that the divergence in monetary policy between the Fed and other central banks will not last long. The letter from the senators also warned that the divergence could lead to a stronger dollar and tighter financial conditions, which often result in economic slowdowns.

Fed's Stance and Economic Projections

Federal Reserve officials are expected to leave interest rates unchanged at their upcoming meeting, avoiding any firm commitment on when they will cut rates. Policymakers are likely to release new economic projections, potentially indicating just two interest rate cuts in 2024, down from three in March. Some economists believe there is a small chance that officials could predict just one cut this year. Gennadiy Goldberg, head of U.S. rates strategy at TD Securities, expects a reduction in September but does not anticipate any hints on timing this week. He noted, "They don’t have to rush. Things are slowing very gradually. They are not falling off a cliff."

The Fed has held interest rates at 5.3% since July, after raising them sharply from near zero starting in March 2022. Higher borrowing costs are expected to slow growth by affecting the housing market and delaying big purchases like cars. However, recent data have given Fed officials reasons to hold off on imminent rate cuts. Job gains last month were stronger than expected, and wage growth picked up, indicating solid demand for workers. Inflation has been stubborn, with price increases slowing rapidly in 2023 but stalling in early 2024. The May Consumer Price Index reading, expected to show slight cooling in core inflation, will be released just before the Fed's decision on interest rates.

Street Views

• QCP Capital (Bullish on Bitcoin and Ether):

  "We do not expect the divergence to last long and see the drop in BTC and ether (ETH) prices as a buying opportunity."