The Stock Market Thinks a September Rate Cut Is in the Bag. But 2 Obstacles Remain That Could Derail It.

Key Points

• Federal Reserve Chair Jerome Powell recently said in a speech that the Fed may soon adjust its policy stance.

• The labor market has slowed a bit in recent months, while inflation has remained above the Fed's preferred 2% rate.

• There has been great debate over whether it's prudent for the Fed to cut rates in September.

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After Federal Reserve Chair Jerome Powell gave what many considered to be a dovish speech at the Fed's annual Jackson Hole Symposium, the stock market was off to the races, as the odds for an interest rate cut at the Fed's upcoming September meeting climbed significantly.

However, traders betting on changes to the federal funds rate have changed their opinion often in recent months, and I think there is the potential for upcoming economic indicators to throw another curveball.

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While the stock market thinks a rate cut is in the bag in September, two obstacles remain that could derail that.

Critical economic data will come out before the Fed's meeting

The Fed will begin its September meeting on Sept. 16 and conclude on Sept. 17 with its decision to either cut rates or leave them unchanged. The Fed's dual mandate is to maintain stable prices and achieve maximum employment, two policies that are increasingly at odds with one another.

Image source: Getty Images.

For several years, the Fed has been dealing with a historically strong labor market, at least as far as the data goes, and extremely high inflation. One of the most intense rate-hiking campaigns in 40 years, which began in 2022, has helped the Fed rein in inflation. In the July report, the Consumer Price Index showed a 2.7% increase year-over-year, while core inflation, stripping out more volatile energy and food prices, was up 3.1%.

Meanwhile, the labor market has started to show signs of slowing, with the economy only adding 73,000 jobs in July and significant downward revisions to previous job numbers. Powell and the Fed have expressed concern about the labor market, which is the main case for the Fed to resume its rate-cutting campaign, which officially kicked off last year. However, with inflation still well above the Fed's 2% preferred target, that could make the case for the Fed to leave rates unchanged. At all costs, Powell and the Fed want to avoid a stagflationary scenario in which unemployment rises and inflation remains high.

Investors cheered the July CPI report, which came in slightly below consensus. However, the Producer Price Index (PPI), a measure of wholesale inflation, rose 0.9% in July from the prior month, well above consensus and the highest increase experienced since 2022. That indicated to some that companies are absorbing higher costs from President Donald Trump's tariffs, which may eventually funnel down to the consumer.

Two big economic data points will be released before the Fed's meeting: the August jobs report on Sept. 5 and the August CPI on Sept. 11. I do think that surprises could make it more difficult for the Fed to justify a rate cut in September. These surprises would likely look like a stronger-than-expected jobs report and higher-than-expected inflation.

The main case for a rate cut right now is to protect the labor market, so if it's doing better than people think, there is less need. If inflation comes in hotter than expected, that's also not supportive of a rate cut because rate cuts stimulate the economy, which could increase inflation and create sentiment that prices will stay high long term.

Look beyond September

During his seven-plus years as Fed chair, Powell has not been one who likes to surprise the market, so I do think it would take something fierce to change the Fed's trajectory for September at this point.

However, investors, as of this writing, are penciling in at least five rate cuts between now and the end of 2026. That has likely played a decent role in driving the market higher this year, as a lower-rate environment tends to be supportive of stock prices.

Ultimately, investors need to pay extra-close attention to the upcoming jobs report and CPI. The market has been fidgety and has been willing to change its mind in a hurry. Since Powell's Jackson Hole speech, the odds of a September rate cut have already declined.

Long-term investors don't necessarily need to do anything, but there could be volatility on the horizon, so understanding what's driving that volatility can help investors stay calm and make more rational decisions.

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