Incoming inflation and retail data may change current expectations on future rate cuts.
Markets from Wall Street to crypto have slipped into a tense holding pattern, with many major digital currencies falling back or below their monthly open price.
What gives? What has changed?
Let’s crack in.
The swing
As markets were absorbing jabs from growing trade tensions, Jerome Powell delivered a subtler but equally powerful blow. One that was enough to shake investors.
What you need to know is, despite some of the Feds preferring to cut rates, the majority – led by the chair, Powell – maintained a hawkish stance, prioritising inflation control over potential growth stagnation.
He reiterated policy was ‘modestly restrictive,’ and that September cuts were not guaranteed unless inflation data materially softened.
On top of interest rates, there’s another tool the Fed uses to control the economy that’s often overlooked – its balance sheet.
Since 2022, the Fed has been steadily pulling money out of the system in a process known as Quantitative Tightening (QT). This is a slow unwind of the large amount of liquidity injected during the Covid crisis.
Think of it as the reverse of money printing. Instead of pumping cash into markets, the Fed is now drawing it back out. They do this by allowing bonds to expire without repurchasing.
This matters. By letting bonds mature and roll off without reinvesting, the Fed is reducing economic growth. Economic growth is key for investors to confidently invest in risk-on, growth markets like crypto. In combination with elevated rates, this liquidity drain plays a role in understanding the state of the US economy.
Now here’s where it gets interesting.
If we know the Fed is actively draining liquidity, keeping rates steady and not concerned about growth, is there even a need for a policy shift?
Piecing it together
The next key meeting for the Fed is around 40 days away, on the 17th of September. Understanding how the market’s expectations are shifting is key to predicting what we might see next in crypto.
When we look at Polymarket’s data, the conviction for a rate cut in September has intensified. This is despite the calls from the Fed that growth and jobs in the economy are holding steady. Does this mean the market is acting irrationally?
So, what is on the road ahead that will provide the next puzzle piece? Next week may prove pivotal.
What comes next?
Next Tuesday’s inflation and retail sales data may reveal the next chapter in this economic tale.
From the Fed’s perspective, three key beliefs stand out:
Growth is on track
The job market is steady
Inflation is still a concern
With that framing, the upcoming data becomes the market’s next ‘tell’ on how the Fed’s thinking might evolve ahead of the September meeting.
If inflation moves higher, it could dash investor hopes for near-term quantitative easing, reinforcing the Fed’s wary stance. On the other hand, a cooler inflation figure would give markets room to breathe, justifying the expectations we’re seeing on Polymarket.
As for growth data, any signs of weakness would challenge the Fed’s view that the US economy remains on solid footing.
That’s why next week’s data will be critical. It’ll either validate the market’s current view – that it’s time for greater liquidity – or shake up expectations and bring price volatility back into play.