With policymakers increasingly confident that price stability is in sight and risks to the labor market rising, the Fed is ready to raise interest rates in September. Chairman Jerome Powell may make that clearer at the July 30-31 policy meeting.
But it’s not a done deal. Fed officials still want to see inflation continue to fall toward their 2% target before committing to cutting the benchmark interest rate from a 20-year high. At the same time, Powell and his colleagues are also determined not to squander the opportunity to achieve a soft landing for the U.S. economy, which has shown at least some signs of losing momentum.
Fed officials are shifting their focus from inflation to the labor market. “This is not just about getting inflation down. We need to be mindful of what’s happening in the labor market,” Powell said in the U.S. House of Representatives on July 10.
The Fed’s preferred inflation measure has fallen to 2.6%, and a once-overheated labor market has slowed to pre-pandemic levels. While Fed officials continue to describe the labor market as strong, they also say it may be approaching a turning point with a steady decline in the number of job openings and a gradual rise in the unemployment rate.
"I do believe we are getting closer to a point where it would be reasonable to cut interest rates," Fed Governor Waller said Wednesday. He said the labor market is in a "sweet spot," but the Fed needs to keep it there, and "the risk of higher unemployment is greater than we've seen in a long time."
Most Fed officials have not revealed the exact timing of the first rate cut, but economists and investors interpreted their speeches as a signal for a September rate cut. "There is a strong impetus within the Federal Open Market Committee (FOMC) to cut rates in September," said Jonathan Pingle, chief U.S. economist at UBS Group. "You can see that many areas of the labor market are cooling down, and these areas have been strong before."
San Francisco Fed President Mary Daly said the cracks in the labor market are not serious enough to require immediate action, but he also acknowledged that the situation could change quickly. "We don't want to see the labor market start to weaken significantly and falter, because by then it's often too late to restore employment," Daly said.
Chicago Fed President Goolsbee said on Thursday that the central bank may need to lower borrowing costs as soon as possible to avoid further deterioration in the labor market, which has been cooling in recent months. Goolsbee noted that while the Fed is still dealing with inflation, several months of improving data have convinced him that officials have returned to their goal of reducing inflation to 2%. But he stressed that the labor market is "definitely an area of concern" because keeping interest rates high while price pressures ease means "substantially tightening" monetary policy.
The number of job openings in the United States, which hit a record high during the pandemic, has fallen back to 2019 levels. Hiring, while still stable, has slowed and is more concentrated in a few industries.
The U.S. unemployment rate has climbed month by month over the past three months and reached 4.1% in June. Although still at a historical low, it is the highest level since 2021. Wage growth has also slowed. Fed Governor Cook said in a speech on July 10 that the Fed is "very concerned" about the unemployment rate and will "respond" if it deteriorates further.
Slowing consumption growth
The rebalancing of the U.S. labor market has been accompanied by a slowdown in consumer spending as high prices and borrowing costs weigh on consumers. In the latest Beige Book released by the Federal Reserve, which compiles observations on business conditions in 12 regional Fed districts, almost half of the districts reported flat or declining economic activity; and in the outlook for the future, companies expect slower growth.
While Fed officials continue to emphasize that policy will be guided by the overall data to be released, they realize that simply maintaining the current stance in the face of slowing inflation is actually a tightening.
Fed officials used words such as "encouraging" and "very good" to describe the recent series of inflation data, which reinforced the Fed's belief that inflation is on the right track. Powell said earlier this week that the data in the previous quarter "did boost confidence to some extent."
Policymakers also stressed that more information is needed before making a big decision to cut interest rates. "We will actually learn a lot between July and September," New York Fed President Williams said on Wednesday.
U.S. Election
Investors are currently fully pricing in the Federal Reserve to cut interest rates in September. Since the end of last month, the yield on the two-year Treasury bond, which is sensitive to Fed policy, has plunged by about 30 basis points.
However, Republican presidential candidate Trump said the Fed should not cut rates before the election. Republican Senator Kevin Cramer of North Dakota said any Fed policy move before November could create a "bad impression."
Early communication from Fed officials may also help make the case to the public - an important task given the fraught political situation of rate cuts less than two months before the U.S. election.
"The risk now is that high interest rates will lead to a real slowdown in the labor market. And because there are political concerns, the Fed wants to convey that message," said Stephanie Roth, chief economist at Wolfe Research.
When asked how the U.S. election might affect the timing of rate cuts, Fed officials stressed that they would not intervene in politics. The Fed even included a special focus section in its semi-annual report to Congress earlier this month discussing the importance of independence and transparency.
The message sent by Powell and his colleagues is that the Fed will ignore the election timeline and do what is best for the economy. "It's time to face up to our dual mission," Daly said. "We have to focus on both aspects to achieve sustainable price stability and full employment while we manage risks."
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2024-07-19
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