"Federal Reserve mouthpiece" Nick Timiraos once again wrote an article to interpret the Federal Reserve's latest interest rate decision.
Federal Reserve Chairman Jerome Powell boldly cut interest rates by 50 basis points, entering a new phase of his pursuit of a soft landing for the U.S. economy. But the move raises new questions that the Fed will have trouble answering.
The rate cut does clarify the answer to a more important question, which is the Fed’s overall goal. It underscores Powell’s desire to prevent past rate hikes from tipping the economy into recession as inflation moves lower. But the main question the Fed can’t easily answer now is: How low will the Fed cut rates, and how quickly?
The Fed is in the dark on both counts. When setting policy, Fed officials typically aim to figure out where their interest rates are relative to the so-called neutral rate, which is unobservable.
Before the coronavirus pandemic, most Fed officials thought the neutral rate had fallen to 2.5% or less. Now, many think it has risen. Possible reasons include soaring government deficits and new sources of investment demand.
Powell described the Fed's most recent rate cut (lowering the federal funds benchmark rate range to between 4.75% and 5%) as "recalibrating policy to a more neutral level over time." While he generally avoids making specific remarks about where the neutral level is, he took the initiative on Wednesday to say that "the neutral rate may be much higher than before the epidemic." "How high?" Powell said: "I don't think we know yet."
The pace of the Fed's rate cuts is also an unknown, and Powell sought to dissuade investors from thinking that a 50 basis point rate cut at the next meeting in November should be the default path. "The committee doesn't feel it's in a rush to do that," Powell said. "I don't think anybody should look at this and say, 'Oh, that's the new pace.'"
Before this meeting, the Fed was unusually unpredictable in deciding whether to initiate a rate cut with a traditional 25 basis point or a more aggressive 50 basis point, and at its next meeting the Fed faces the prospect of similar uncertainty from continued mixed signals on the economy.
Officials will also receive two months of labor market data before their Nov. 6-7 meeting, including a report due less than a week before the meeting.
Mester, who stepped down as Cleveland Fed president in June, said this week’s decision represented a valiant effort to manage the risk of a hiring slowdown as inflation cools, but that uneven communications around the move ahead of the meeting could happen again. “At the next meeting, it’s going to be ‘25 or 50, why not another 50 basis point cut?’ That makes it more complicated,” she said.
To be sure, Powell tried to put up guardrails around expectations of another 50 basis point rate cut by pointing to the rate forecasts officials have released. “That’s not entirely convincing because the last set of quarterly forecasts (in June) never signaled a 50 basis point cut,” said Dean Maki, chief economist at hedge fund Point72 Asset Management.
Fed officials are trying to balance two risks: One is that they drag their feet on cutting rates, causing unemployment to rise, making officials rush for bigger rate cuts.
“It’s a race between a decelerating labor market and the Fed being less restrictive before that labor market weakness causes a slowdown in the economy,” said Priya Misra, portfolio manager at JPMorgan Asset Management. “If this is the beginning of labor market weakness, they should have more urgency to continue cutting rates more aggressively.”
Another risk is that the Fed moves too quickly in cutting rates. "If the Fed continues to cut rates by 50 basis points when the economy doesn't need it, it increases the likelihood that inflation will remain above the Fed's 2% target," Markey said.
Even if tactical questions remain, Mester said Powell’s speech last month in Jackson Hole, Wyoming, and concrete actions this week have answered larger questions about the Fed’s strategy.
Earlier speeches made it clear that he would not welcome further weakness in the labor market. "He was very clear in his speech at Jackson Hole," Mester said.
“I know everybody is focused on the 25 versus 50 question, but the take-home message is, listen, the committee is becoming more confident that inflation will move back toward 2% over time, and they’re also watching the risks to the labor market.”
Powell tried to strike a balance between expressing concern about the economy and complacency about employment risks. "It's worth watching, and we're watching," he said. "There's a view that the time to support the labor market is when the labor market remains strong, not when layoffs start to occur."
Over the past two weeks, more former Fed officials have urged the central bank to start with larger rate cuts to better balance the risks facing the economy, even as public comments from some of Powell’s colleagues have suggested they would prefer to start with smaller cuts.
Powell prioritizes consensus building, as evidenced by the fact that there have been no dissenting votes in 17 consecutive meetings, but this week's meeting broke that streak. "I don't know if he could get the committee to agree, but he did," Misra said. "So that speaks to his influence on the committee as well."
Article forwarded from: Jinshi Data
