For more than two years, fighting inflation has been the top priority in the eyes of the Federal Reserve. In a shift that global markets have been eagerly awaiting, that is about to change.
Fed officials are ready to cut interest rates in September as they grow more confident that price stability is within reach while risks to the labor market are growing. They have laid the groundwork for the coming moves in speeches in recent weeks, and Powell is likely to make that clearer after the July 30-31 policy meeting.
Still, it’s not a done deal. Fed officials still want to see monthly price data continue to decline toward their 2% annual inflation target before committing to lowering interest rates from two-decade highs. But Powell and his colleagues are also determined not to squander the chance to soft-land an economy that’s showing at least some signs of losing steam.
“This is not just about getting inflation down,” Powell told House members on July 10. “We need to pay attention to the state of the labor market.”
The Fed’s preferred inflation measure has retreated to 2.6%, and a once-overheated labor market has cooled to pre-pandemic levels. While officials continue to describe the labor market as strong, they also say it may be approaching a turning point as job openings steadily decline and the unemployment rate gradually rises.
“I do believe that we are getting closer to the point where we should be moving down the policy rate,” Fed Governor Waller said on Wednesday. He said the labor market is in a “sweet spot” but the Fed needs to keep it there. “The upside risks to the unemployment rate are greater than we have seen in a long time,” he added.
Most officials have not said when the first rate cut would come, but economists and investors interpreted their comments as foreshadowing action in September.
“There is strong momentum within the committee to cut rates in September,” said Jonathan Pingle, chief U.S. economist at UBS Group AG. “You are seeing cooling in many areas of the labor market that have been strong.”
San Francisco Fed President Mary Daly said in an interview that the cracks in the job market are not yet serious enough to require immediate action. However, policymakers also acknowledged that the situation could take a sharp turn for the worse. Daly said: "We don't want to see the labor market start to weaken significantly and falter, because by then, it is often too late to recover the labor market."
Job openings, which hit an all-time high in the post-pandemic period, have fallen back to 2019 levels. Hiring, while still solid, has slowed and become more concentrated in a few industries.
The unemployment rate has climbed month by month over the past three months, reaching 4.1% in June, still at a historical low, but the highest since 2021, and wage growth has also slowed. In a speech on July 10, Fed Governor Cook said the Fed was "very concerned" about the unemployment rate and would "respond" if it worsened.
Consumption slowdown
As the labor market rebalances, Americans' consumer spending has slowed as prices and borrowing costs remain high.
In the Federal Reserve's latest Beige Book of economic activity, almost half of the districts reported flat or declining economic activity. Looking ahead, businesses expect slower growth.
While officials continue to emphasize that policy will be guided by all data as they come in, they also recognize that maintaining the current stance amid slowing inflation is effectively a tightening move.
“If you’re going to tighten, you should make sure you’re tightening by choice and not by default,” Chicago Fed President Goolsbee said in an interview.
Policymakers have used words such as “encouraging” and “very good” to describe a recent string of inflation data, reinforcing the Fed’s belief that prices are on the right track. Powell said earlier this week that last quarter’s data “did add some confidence.”
Policymakers also made a point of stressing that more information was needed before making a major decision to cut interest rates.
“We’re actually going to learn a lot between July and September,” New York Fed President John Williams said in an interview published Wednesday.
Election issues
Investors have already deemed a September rate cut a near certainty. The yield on the two-year Treasury note, which is sensitive to Fed policy, has fallen sharply by about 30 basis points since the end of last month.
Early communications from Fed officials also help make the case to the public — an important task given the political risks of cutting rates less than two months before the presidential election.
Republican candidate and former President Trump said in an interview with Bloomberg Businessweek that the Federal Reserve should not cut interest rates before the election. Republican Senator Kevin Cramer of North Dakota said any policy move before November could create a "bad impression."
“The risk now is that they’ll cause a real slowdown in the labor market,” said Stephanie Roth, chief economist at Wolfe Research. “Because of the political concerns, they want to get that message across.”
When asked how the presidential race might affect the timing of rate cuts, Fed officials stressed that the central bank stays out of politics. The Fed even devoted a section of its semiannual report to Congress earlier this month to the importance of independence and transparency.
The message from Powell and his colleagues is that the Fed will ignore the election timeline and do what is best for the economy.
“Now is indeed the time to keep our dual mandate in mind,” Daly said. “We must focus on both of them as we manage risk to achieve sustainable price stability and full employment.”
The Federal Reserve will hold a meeting on July 30-31. According to Fed rules, policymakers cannot comment on monetary policy from this Saturday (July 20) until the end of the meeting.
Article forwarded from: Jinshi Data
