Rate cuts by the Fed are expected this week
It is widely expected that the Federal Open Market Committee will lower interest rates in their next move. The minor inflation concern in February and March turned out to be a temporary fluctuation, possibly due to inaccurate seasonal adjustment. When will the process of cutting rates commence?
The Federal Reserve Chairman, Jerome Powell, and his colleagues have a clear understanding and have effectively communicated that risks exist on both sides. If they reduce spending prematurely, there is a possibility that inflation could make a comeback or, more probable, fail to decrease to the Federal Reserve’s desired 2% target. If interest rates are kept at elevated levels for an extended period, there is a risk that the economy could experience a slowdown or potentially enter a recession.
Financial resources are currently limited. Considering the inflation rate fluctuating between 2.5% to 3%, depending on the measurement, the current federal-funds rate of 5.25% to 5.5% results in a real interest rate of approximately 2.5% to 3% after adjusting for inflation. The Fed is exerting pressure on the economy, but it is certainly not causing it to suffocate. In due course, rates will need to decrease. But when will it happen?
Investors are speculating that the FOMC will opt for rate cuts during its upcoming meeting on Sept. 17-18, and I share the same expectation. There are no meetings planned for October, and it is highly unlikely that rate cuts will be implemented at the Nov. 6-7 meeting, which takes place right after Election Day. That would be inappropriate. If the FOMC does not begin cutting rates on Sept. 18, it may choose to wait until its Dec. 17-18 meeting, which is quite a while away and perhaps too far in the future.
However, there is an alternative: reducing rates during the July 30-31 meeting. Although it may not be a widely considered option, perhaps it should be, as suggested by Aaron Back in a recent article in the Journal. I agree with Mr. Back, however, it seems that the FOMC holds a different perspective. Even the committee’s most cautious members are not indicating any signs of support for a July 31 decision.
Instead, Mr. Powell recently stated: “We aim to have greater certainty that inflation is steadily decreasing towards 2%… before we consider easing our policy.” Other members of the FOMC have expressed similar views.
That seems quite logical. However, considering the inherent uncertainties in predicting inflation, it is uncertain how much more confident the committee members will ever become. Waiting until we actually reach the promised 2% land might make them too late.
What is the reason for the delay? It is important to keep in mind that the Federal Reserve has a dual mandate, which involves striving for both low inflation and high employment. For a period of time, monetary policy was not achieving the desired low-inflation outcome, prompting Fed officials to focus their efforts on addressing this issue. However, following the peak in personal consumption expenditures inflation (the Fed’s preferred measure) in June 2022, inflation has been steadily declining. Aside from a small increase in March, the 12-month PCE inflation rate has been consistently stagnant or declining since last September. Seems to be a trend from my perspective.
What about the other aspect of the mandate—ensuring a strong job market? The performance of the U.S. economy has been remarkable. The national unemployment rate has remained at 4.1% or lower for an impressive 32 consecutive months. Over the course of those 32 months, the United States has seen a significant increase in job growth, with over 10 million new jobs being added to payrolls. This translates to an average of 315,000 jobs being created each month.
Although there has been a surge in job opportunities, the pace of job creation in America has recently decelerated. Job creation in 2024 has seen a monthly average of 191,000, which indicates a positive trend, albeit at a slightly slower pace. Furthermore, the unemployment rate, although remaining relatively low, has been gradually increasing. The most recent four monthly figures show an increase of 3.8%, 3.9%, 4%, and 4.1% respectively. While the Federal Reserve continues to address its dual mandate, there has been a slight decline in the focus on employment, while the attention on inflation has shown signs of improvement.
From the perspective of an economist, the Federal Reserve consistently emphasizes its reliance on data when making decisions. It is evident in various indicators such as employment, retail sales, and other economic factors that the overall state of the economy is gradually cooling off. The Federal Reserve has acknowledged this.
Although the conditions seem favorable for a rate cut in September, there’s no need to delay. There is still an opportunity for a cut by July 31. The FOMC has become accustomed to an approach of avoiding unexpected interest-rate changes. Markets are often provided with advanced information about future events. If Mr. Powell were to drop a hint or two beforehand, a 25-basis-point rate cut on July 31 would still be somewhat surprising, but not entirely unexpected. I think the markets would be quite pleased.
It would be prudent to include a cautionary note with any initial rate cut, emphasizing that further cuts will only be made if the data supports it. On June 6, the European Central Bank made a move by reducing its main rates by 25 basis points. However, it also cautioned that it was not making any firm commitments regarding the rate path.
When it comes to advocating for a quick rate cut, I can’t help but feel a bit like Don Quixote. However, I can easily identify a windmill when it comes into view. It is highly unlikely that a rate cut will occur on July 31, although there might be some valid arguments in favor of it. If the change is implemented sooner rather than later, it would be welcomed by the markets.
