The Federal Reserve is this week expected to set the stage for lower borrowing costs as US inflation has taken a favourable turn and the labour market continues to soften.
The Federal Open Market Committee (FOMC) is poised to again hold its benchmark interest rate steady at a 23-year high of 5.25-5.5 per cent when its two-day gathering ends on Wednesday. While the rate decision itself looks to be uneventful, the meeting will serve as an important platform to further tee up a monetary policy pivot as early as September.
“The Fed is moving closer to a rate cut, and its communications this week should reflect that,” said Brian Sack, the former head of the New York Fed’s Markets Group, who is now head of macro strategy at hedge fund Balyasny Asset Management.
What has given officials latitude to more directly embrace the idea of rate cuts is clearer evidence that after many fits and starts, inflation is finally being wrestled under control.
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Consumer price growth has eased meaningfully in recent months, taming fears that flared up earlier this year after an unforeseen hiccup. And once a concerning contributor to inflationary pressures, the labour market has also entered a new phase. Hiring has slowed from its red-hot pace, resulting in slower wage growth.
Lay-offs are rising, pushing the three-month average unemployment rate up 0.43 percentage points compared with its lowest point in the past 12 months – just shy of the 0.5 per cent trigger for the SAHM Rule, which marks the start of a recession.
Officials want to maintain a healthy labour market and recognise that keeping their policy rate too high for too long jeopardises that.
The Fed is likely to acknowledge these developments directly on Wednesday in a revised policy statement and during the press conference held by chairman Jay Powell.
Back in June, the FOMC wrote that there had been only “modest further progress” towards its goal of getting inflation to 2 per cent and that it was “highly attentive to inflation risks”. Moreover, it has long said that it would not deem it appropriate to reduce rates until it had “gained greater confidence” that inflation was moving “sustainably” towards their target.
Economists expect the Fed to acknowledge that further progress has been made. The central bank’s preferred inflation gauge now hovers at 2.6 per cent, well below its 2022 peak.
They also believe the statement will emphasise that elevated inflation is not the only risk confronting the Fed now that the labour market has softened. As Powell has stressed, the central bank is also at risk of causing undue job losses if it fails to act quickly enough to offer relief to American businesses and borrowers.
Lastly, the FOMC is likely to affirm it is more confident about its handle on inflation and in turn its readiness to lower rates.
Mr Powell and other officials have so far demurred from commenting specifically about the timing of the first move, instead saying that decisions will be made meeting-by-meeting and hinge on how the data evolves.
Between the July and September gatherings, the Fed will receive two sets of inflation and jobs reports, among other updates. Forecasts suggest the incoming information will confirm the need to reduce rates.
Some economists argue the Fed is on the verge of making a mistake in delaying a rate cut until September, given the slowdown under way in the economy.
“Although it might already be too late to fend off a recession by cutting rates, dawdling now unnecessarily increases the risk,” former New York Fed president Bill Dudley said last week.
The Fed, however, sees several benefits to waiting.
For one, the central bank has been wrong-footed in the past and officials want to be absolutely certain they have a handle on inflation before making any big policy moves.
There also remains a range of views internally about the appropriate path forward for rates. As recently as June, there was a nearly even split between policymakers projecting just one quarter-point cut compared with two for the year.
“Powell probably feels that he can’t really get the consensus together to go until September,” said Ellen Meade, who served as a senior adviser to the Fed’s board of governors until 2021 and is now at Duke University.
“There’s a risk that you don’t go soon enough, but there is also a risk that you go a little too soon and you have to reverse course,” she added. “Given what they experienced with inflation picking up at the beginning of the year, they’re probably leaning into that second risk.”
Peter Hooper, vice-chairman of research at Deutsche Bank, also deems it prudent for the central bank to wait until September to kick off its easing cycle. In the event that the labour market weakens much more quickly and by a larger magnitude than expected, the Fed could get back to a “neutral” policy setting – one that is no longer beating back demand – “fairly quickly”, he said.
Hooper, who worked at the Fed for almost 30 years, sees scope for additional rate reductions in November and December before the central bank presses pause until September 2025. At that point, his team predicts quarterly cuts that gradually bring the policy rate back to between 3.5-4 per cent.
Meanwhile, unexpected strength in UK services inflation has left the Bank of England’s meeting on Thursday on a knife edge, as policymakers weigh whether to push ahead with the first reduction in interest rates since 2020. – Copyright The Financial Times Limited 2024
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