The Fed’s rate-cut strategy is constantly changing
Jerome Powell, the Chair of the Federal Reserve, found it necessary to allay the concerns of certain doubtful colleagues regarding the potential misinterpretation of the central bank’s intentions. This occurred as he guided them towards a significant reduction in borrowing costs at the summer’s conclusion, opting for a bold half-point cut that exceeded typical measures. They now face yet another possible turning point. In November, officials once more reduced their benchmark rate, this time by a quarter point. Market participants largely anticipate a third successive reduction in interest rates this week.
Powell is navigating the complexities of monetary policy as indications suggest the labor market is stabilizing and inflation appears slightly more robust than previously assessed in September. He encounters skepticism from certain colleagues regarding the ongoing cuts, while others who initially supported those early decisions exhibit diminished conviction. This week, a potential course of action could involve a reduction of a quarter point, followed by the release of updated economic forecasts that would subtly indicate the central bank’s inclination to adopt a more measured approach to future cuts.
“At present, both a reduction or a maintenance of the current rate could be warranted,” stated Jon Faust, who acted as a senior adviser to Powell from 2018 until earlier this year. The statements made by officials regarding the trajectory of the fed-funds rate are expected to hold greater significance than the specific decisions made concerning the December meeting. The federal funds rate exerts a significant impact on borrowing costs across the economy, affecting interest rates on mortgages, credit cards, and auto loans alike. Increasing it generally restrains hiring, expenditure, and investment, whereas decreasing it stimulates these activities. However, these effects operate with what is referred to as long and variable lags, indicating that central bankers may remain uncertain for a year or more regarding whether they have implemented excessive or insufficient tightening.
A handful of officials have indicated they might contest a reduction this week. The “hawks” express concern over the potential erosion of the Fed’s credibility if inflation persists significantly above the target for a fourth or fifth consecutive year. While officials maintain that price growth is expected to decelerate towards their target, there may be a growing skepticism regarding this outlook, particularly in light of President-elect Donald Trump’s commitments to deport workers and implement tariffs upon assuming office next month. The proposed measures could potentially counteract two trends that have supported policymakers’ optimistic inflation projections: declining goods prices and a deceleration in wage increases.
“Were I a voting member of the committee at this moment, I would oppose any reduction,” stated Eric Rosengren, who held the position of Boston Fed president from 2007 to 2021. Concerns persist regarding the buoyant state of the stock market and the allure of speculative assets like bitcoin, which may fuel spending patterns that perpetuate inflationary pressures. In light of recent economic developments, Fed governor Michelle Bowman remarked in a speech this month that it is challenging to consider the current level of interest rates as restrictive.
Dallas Fed President Lorie Logan cautioned against excessive cuts, highlighting what she perceives as a misjudgment that a “normal” interest rate for the economy is significantly lower. She likened the scenario to that of a ship captain whose depth finder could misinterpret mud for water. A separate cohort of officials, including Powell, has indicated that they harbor similar apprehensions but believe that the Fed is not in imminent danger of excessive rate cuts—at least for now—considering the significant increases implemented over the last two years. “We are acutely aware of the potential danger in overreaching too swiftly, yet equally cognizant of the peril in not advancing sufficiently,” Powell remarked last month. “It appears that we are precisely positioned as required.”
Labor markets persist in a precarious balance. The current landscape reveals a duality: hiring rates remain subdued, yet layoffs are equally restrained. Over the six months leading up to November, the economy has seen an average addition of more than 140,000 jobs, a commendable statistic. The unemployment rate has risen to 4.2%, up from 3.7% at the start of the year. The economic sectors most vulnerable to elevated interest rates, particularly housing, have exhibited a sluggish response to the recent reductions.
A significant aspect of Powell’s role involves cultivating consensus within a frequently unwieldy assembly of 18 additional officials. The past year has presented challenges, as inflation has experienced a fluctuating decline. In the past year, certain hawkish officials, previously resistant to indicating a cessation of rate hikes, have started to adjust their stance following a series of more favorable inflation reports. During the economic forecasts presented at the December 2023 meeting, Fed governor Christopher Waller outlined a plan for six quarter-point reductions in 2024—surpassing the expectations of his peers. Subsequently, as inflation showed signs of stagnation in the spring, Waller proposed that the Federal Reserve might maintain its current stance until the year’s conclusion. For several months, Powell and his associates maintained that a credible entry point was essential for initiating cuts. “The initial instance of altering one’s course often assumes a significance that may exceed its true weight,” remarked Faust. “Individuals interpret it as an indication that the coast is clear.”
By Labor Day, Powell was increasingly apprehensive about the possibility that the central bank, chastened by its misjudgment of inflation in 2021, might overreact by maintaining elevated rates, thereby stifling rate-sensitive sectors of the economy. The labor market has started to exhibit indications of a potentially more pronounced slowdown than previously anticipated, as evidenced by the unemployment rate rising to 4.3% in the data published for August. Inflation has once again begun to retreat from its previous levels.
Federal Reserve officials generally aim to orchestrate significant actions while minimizing market surprises. On September 6, the final day prior to the commencement of the customary premeeting “quiet period,” two speeches prompted investors to speculate that a modest quarter-point increase was favored. However, in private discussions with a select group of advisers, Powell determined that initiating with a substantial half-point reduction was the appropriate course of action. The concept draws inspiration from the approach of former Fed Chairman Alan Greenspan, who frequently influenced his peers by presenting policy options as a means of navigating various risks.
The likelihood of lamenting a substantial rate reduction was considered minimal. The protracted delay in rate cuts led officials to believe that, even with a robust economic performance, they could afford to moderate the pace of the anticipated reductions. In contrast, implementing a modest reduction, only to find that the labor market is experiencing a significant downturn, would present a considerably more challenging issue to rectify. Powell generally engages in telephone consultations with all 12 regional bank presidents and convenes with the six Washington-based governors on the Thursday and Friday preceding the upcoming week’s meeting. Powell and his team additionally distribute a collection of briefing documents that delineate the rationale for three distinct policy options.
A few required minimal persuasion to embark on significant ventures. Some expressed discomfort. Previous cuts of half a percentage point have aligned with periods of significant financial strain. Bowman, having cautioned against the potential for persistent inflationary pressures, recognized upon reviewing the policy briefing materials that she could not endorse Powell’s proposal. She ultimately cast a dissenting vote—the first instance of such a decision by a Fed governor since 2005. In order to mitigate dissent and garner support from colleagues who echoed her concerns, Powell persuaded them that he could frame the decision in future public statements as a strategic adjustment from a position of strength, rather than an impulsive rush to reduce rates.
“There is no indication that the committee is hurrying to finalize this matter,” Powell remarked during a press conference following the meeting. He described the “good, strong start” to rate reductions as indicative of our resolve to avoid falling behind. Recent adjustments to government data, released shortly after the meeting, indicated that income growth and personal savings rates were more robust than previously indicated. The elimination of those anxiety sources regarding a potential recession implied that perhaps the broader action taken was unwarranted.
Waller, who initially supported a more modest reduction but was ultimately swayed to endorse the more substantial adjustment, recently brushed aside inquiries regarding any potential regrets about his choice. He likened it to the process of purchasing car insurance. “One might ponder, ‘What is the rationale behind purchasing car insurance?’ “I might have an accident,” he remarked during an event this month. The incident did not occur. Do you ever reflect, ‘It was an unwise choice to purchase car insurance?’ No.
