By Nicholas Jasinski
Chair Jerome Powell has spoken plenty about the Federal Reserve's plan to lower rates. Now that the central bank has cut, other officials are chiming in -- and so is Wall Street.
Wall Street and the Fed agree the half-point cut in the fed-funds rate is the first in many, but they disagree on how quickly rates will decline from here. Fed policymakers are set on continuing to lower interest rates at a slow and steady pace, encouraged by a still-solid economy, a labor market in balance, and slowing inflation.
Markets, meanwhile, appear to be betting that worsening economic and labor conditions will force the Fed to move more quickly. Stock indexes are at record highs, boosted this week by the announcement of a raft of stimulus measures in China and the prospect of lower interest rates ahead.
Futures are pricing in roughly even odds of a quarter-point reduction or another jumbo cut at the Fed's next meeting in November -- then significantly more easing in 2025.
The Fed has a dual mandate: to pursue maximum employment and ensure price stability. After two years of inflation fighting, the risks to achieving those goals are in better balance today, according to Fed officials. That means backing off of restrictive interest rates.
"In my judgment, the balance of risks has now shifted away from higher inflation toward higher unemployment," wrote Minneapolis Fed President Neel Kashkari in an essay published on Monday.
In his late-August Jackson Hole keynote address, Powell also laid out the justification for beginning to lower interest rates: a softening labor market and inflation closing in on the central bank's 2% annual target. The Federal Open Market Committee obliged on Sept. 18, voting to lower its target for the federal-funds rate by half a percentage point, to a range of 4.75% to 5.0%, after holding its rates steady since July 2023.
In his postmeeting press conference, Powell was eager to characterize the rate move as a "recalibration" of policy, not a panicky move to rescue a deteriorating economy. While growth has remained solid -- the Atlanta Fed's GDPNow model currently estimates a 2.9% annualized growth rate in the third quarter -- the job market has cooled off from overheated levels of the Covid-19 pandemic rebound. The unemployment rate has climbed from a half-century low of 3.4% last year, to 4.2% as of August. That's still low by historical standards, but past increases in the unemployment rate have tended to continue, rather than plateau.
In the absence of a recession, the Fed doesn't need to rush. And the destination of cuts is the neutral rate of interest, or the level of rates that neither stimulates nor restricts economic growth. The median forecasts in September's so-called dot plot implied a percentage point of rate cuts this year followed by another point by the end of 2025, which would bring the target to a range of 3.25% to 3.5%.
"While future actions...will depend on data we receive on inflation, employment, and economic activity, if conditions continue to evolve in the direction traveled thus far, then additional cuts will be appropriate," Fed Gov. Adriana Kugler said on Wednesday.
The median longer-run estimate of the fed-funds rate rose for a third-straight quarter in the Fed's September Summary of Economic Projections, to just below 3%. That is seen as the committee's collective estimate of the neutral rate, which most economists these days estimate is likely to be in the neighborhood of 3%.
"There is plenty of debate about the level of the neutral rate in the United States and elsewhere," Atlanta Fed President Raphael Bostic said. "However, the disagreement on the true neutral level was inconsequential, at least for me at [the September] meeting. Wherever the neutral rate is, I don't know anyone who would plausibly argue with the notion that we are a fair distance above it."
En masse, FOMC members expect to nail the landing. The September Summary of Economic Projections has median estimates calling for real GDP growth of 2% annually through 2027, with the unemployment rate peaking at just 4.4%.
Rather than reacting to a faltering economy once it arrives, the Fed is working to get ahead of more softening. Officials would like to press pause on the economy.
"The overall economy has some warning signs, but it's got some real strengths," Chicago Fed President Austan Goolsbee said on Monday. "If you could just freeze it in place right now, exactly where it is, you would."
Another recent argument put forward by Fed officials for "recalibrating" interest rates is the progress made on reducing inflation. The annual change in the consumer price index peaked at 9% in June 2022. It was up 2.5% year over year in August.
As price growth has declined, the real -- or inflation-adjusted -- fed-funds rate has climbed, effectively making policy more restrictive, Goolsbee and others have argued.
And while the year-over-year change in prices remains higher than desired, recently monthly prints have come in at a pace that would hit the Fed's 2% target if they continued for a year. "That's what put me over the edge to think [cutting by half a percentage point] was the right thing to do," Fed Gov. Christopher Waller said on Sept. 20.
Not all Fed officials are ready to declare mission accomplished on the inflation-fighting front. Gov. Michelle Bowman cast the lone dissenting vote on Sept. 18, preferring a quarter-point cut. She cited the risk of a rebound in inflation in the coming months.
"In my view, the upside risks to inflation remain prominent," Bowman said on Tuesday. "Global supply chains continue to be susceptible to labor strikes and increased geopolitical tensions, which could result in inflationary effects on food, energy, and other commodity markets. Expansionary fiscal spending could also lead to inflationary risks, as could an increased demand for housing given the longstanding limited supply, especially of affordable housing."
As usual, Fed officials left themselves plenty of flexibility for their next moves. Waller said if unemployment worsens and inflation continues to slow further, officials could do more half-point cuts. If inflation rebounds, on the other hand, the Fed could pause on lowering rates.
The next FOMC meeting will be on Nov. 6 and 7, in the days after the U.S. election.
"While the totality of the data will always be important, the burden will be on incoming labor market data to provide the Fed with greater confidence that the softening trend is stabilizing," wrote Deutsche Bank Chief U.S. Economist Matthew Luzzetti on Wednesday.
So circle two dates on the calendar in particular: Oct. 4, when the September jobs data will be released, and Nov. 1 -- the date of the October jobs report, during the FOMC's premeeting quiet period.
If the unemployment rate climbs above the median 4.4% year-end forecast in the FOMC's September dot plot and nonfarm payrolls growth remains around 100,000 a month or lower, another half-point cut will certainly be on the table in November, per Luzzetti. More downward revisions to the initially reported hiring totals could add to the case for accelerating rate cuts.
Markets are betting on just that. It's too bad Wall Street doesn't get a vote on the FOMC.
Write to Nicholas Jasinski at nicholas.jasinski@barrons.com
This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
September 26, 2024 18:03 ET (22:03 GMT)
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