Wells Fargo expects the Fed to keep rates steady at its July meeting. Here's why.

Wells Fargo analysts assess the U.S. economy is decelerating, noting that Q1's 0.5% GDP contraction overstated weakness while Q2's projected 1.8% expansion may overstate strength, citing slowing consumer spending and investments, alongside a softening labor market. Given this murkiness and persistent inflation, they anticipate the Federal Reserve will maintain current interest rates at its upcoming meeting. However, the firm projects potential rate cuts could begin in September, followed by further reductions, if tariff-driven inflation proves temporary and labor market conditions continue to soften.

Analysis

Wells Fargo analysts project a deceleration in the U.S. economy, characterized by conflicting headline data. The reported 0.5% GDP contraction in the first quarter is seen as an overstatement of economic weakness, distorted by a surge in imports ahead of tariff implementations, while underlying real final sales to private domestic purchasers grew by nearly 2%. Conversely, a projected 1.8% real GDP expansion for the second quarter may overstate economic strength. This forecast is artificially lifted by an expected 25% drop in imports, masking sluggish fundamentals, including a mere 1.3% rise in real consumer spending and contractions in business and residential investments of 0.6% and almost 5%, respectively. This slowdown is corroborated by a deceleration in private sector payrolls. In response to this murky outlook and above-target inflation, the Federal Reserve is expected to maintain its policy rate at 4.25%-4.5% in its upcoming July meeting. Wells Fargo anticipates a potential pivot later in the year, forecasting a 25 basis point rate cut in September, contingent on tariff-related inflation proving modest and the labor market softening further. However, this outlook contrasts with minutes from the Fed's June meeting, where most participants viewed rate cuts as more appropriate for later in 2025, highlighting a significant divergence between analyst expectations and the central bank's recent signaling.

Key Decisions for Investors

• Given the conflicting GDP signals and weakening underlying components like consumer spending and investment, investors should consider a cautious stance on cyclical sectors sensitive to economic deceleration.
• The divergence between Wells Fargo's forecast for rate cuts in late 2024 and the Fed's more hawkish signaling for 2025 creates policy uncertainty; therefore, closely monitor upcoming inflation and labor market data for any signs that could precipitate an earlier Fed pivot.
• Anticipate continued market volatility as investors digest the murky economic outlook and the Fed's 'wait-and-see' approach, which will likely delay significant policy decisions until at least the September FOMC meeting.