Nick Timiraos, a reporter for the Wall Street Journal known as the "New Fed News Agency," wrote on Wednesday that although on the surface Federal Reserve Chairman Powell's congressional testimony over the past two days did not have any impact on the market, it actually hinted that the threshold for interest rate cuts has been lowered, and this change in stance may be more lasting than the shift that triggered a market surge at the end of last year.
Around December, Powell and several colleagues signaled that they could begin cutting rates as soon as the middle of this year if inflation, which was clearly cooling at the time, continued on its path. In March, Powell acknowledged during Capitol Hill testimony that the Fed was “not far” from gaining the confidence it needed to cut rates.
The case for lower interest rates proved to be built on shaky ground. When inflation picked up in the first quarter and economic growth was solid, the case for lower interest rates fell apart.
But when Powell returned to Capitol Hill this week, he again began laying the groundwork for a rate cut, and it could prove to be a more solid foundation. He noted that a cooling labor market meant potential sources of persistently high inflation had diminished. He also said further weakness in the job market was likely unnecessary and unwelcome.
Powell said on Wednesday that striking a balance between ensuring inflation returns to the Fed's 2% target while preventing a sharp increase in layoffs "is the number one thing that keeps me up at night." "Trying to make the decisions that are most likely to achieve that goal, that's what I think about in the early hours of the morning," he said.
On Tuesday, Powell bluntly stated that the labor market "is not a source of broad inflationary pressures in the economy," a revealing view given how concerned Fed officials have been over the past two years about the potential for an overheated labor market to sustain high inflation.
Instead, Powell said, high inflation is caused by a conflict between very strong demand and supply chains that have been disrupted by the pandemic. Inflation has fallen despite solid economic growth last year as supply bottlenecks in labor and product markets have eased.
He went further on Wednesday: “I think we now have a better understanding of where (inflation) is coming from because we can see what’s making it go away.”
Inflation, the Fed’s preferred measure, slowed to 2.6% in May from a year earlier, down from 4% a year earlier but still above the Fed’s 2% target. The Labor Department will release another key inflation data on Thursday, the Consumer Price Index (CPI) for June.
Powell's testimony this week did not elicit a strong reaction from investors, perhaps because he did not suggest that the Fed was likely to cut interest rates at its meeting later this month, and market participants have begun to expect a rate cut in September.
Still, Powell’s latest comments are noteworthy for veteran Fed watchers because they suggest the bar for rate cuts may be lower than it was a few months ago.
“The tide has turned,” former Fed Governor Laurence Meyer said in a note to clients on Wednesday. Disappointing inflation data earlier this year made Powell anxious, so he was careful not to pre-commit to upcoming actions by giving hints.
But Powell’s comments now suggest he believes “inflation is back on track” and that the labor market is “on the verge of an unnecessary slowdown,” Meyer said.
The Fed is raising interest rates at the fastest pace in 40 years in 2022 and 2023 to fight inflation. Fed officials have kept the benchmark rate between 5.25% and 5.5% since July last year, the highest level in more than 20 years.
Officials are trying to balance the risks of cutting rates too slowly, which could push inflation above the Fed’s target, and too quickly, which could hurt employment.
While layoffs are low right now, they tend to rise quickly as the economy weakens, which suggests rates should not be kept too high. The unemployment rate has climbed this year from 3.7% at the end of last year to 4.1% in June, largely because hiring has slowed, with new or re-employed workers taking longer to find jobs. However, the situation is not too worrisome at this point, as layoffs remain low.
Moreover, while immigration has boosted the supply of workers over the past two years, it is possible that immigration will decline in the coming months, causing the unemployment rate to fall back.
However, Fed officials, including Powell, have signaled that they are more vigilant to signs that unemployment is continuing to climb for worrisome reasons.
“The work on inflation is not done. We have more work to do. But at the same time, we also need to be mindful of the state of the labor market, where we have seen a fair amount of slack,” Powell said.
The article is forwarded from: Jinshi Data