Update 800 — See You in September:
Powell Signals Rate Cut… Just Not Yet
Today’s decision by the Fed to hold the prime rate steady at the 5.25 to 5.5 percent range yet again — where it has been for the past year — surprised no one. The long struggle to bring inflation down to the Fed’s two percent target without triggering a slowdown, let alone a recession, has paid off, with prices now just a few yards from the goal line.
But today was apparently not the time to spike the ball and declare victory. It is reasonable to ask — why not? The Fed meets on September 17-18 while the labor market continues to soften and unemployment creeps upward. Is it safe for the Fed to wait another six weeks or does it run risks by doing so? See below.
Best,
Dana
Fed Holds Interest Rate Steady, Hints at Sept. Rate Cut
Will the Fed begin cutting interest rates at its next meeting in September? That’s the question that overshadowed the Federal Open Market Committee’s (FOMC) highly-anticipated decision to hold interest rates steady for the eighth consecutive time at the conclusion of its July meeting today.
In his press conference following the FOMC’s meeting today, Federal Reserve Chair Jerome Powell hinted several times that the FOMC may do exactly this. Powell said that “the broad sense of the Committee is that the economy is moving closer to the point at which it will be appropriate to reduce our policy rate” adding that the question in September will be whether the “totality of data, the evolving outlook, and the balance of risks are consistent with rising confidence on inflation and maintaining a solid labor market.” He said that “if that test is met, a reduction in our policy rate could be on the table as soon as the next meeting in September.”
Powell said that “The job is not done on inflation,” and that FOMC officials opted not to cut rates today, as the average FOMC official believed that the economy had not yet made enough progress on inflation but that we were “getting closer.”
The Fed has held the target federal funds rate at the 5.25 to 5.5 percent range, a 23-year high, since last July. The Fed began tightening credit conditions in early 2022, raising the interest rate from near zero to its current level in its most aggressive series of interest rate hikes since the early 1980s.
The Fed’s preferred measure of inflation – the personal consumption expenditures (PCE) price index – has fallen significantly from its peak of 7.1 percent in June 2022. PCE had been approaching the Fed’s target of two percent for months, despite a blip in the early months of 2024, and fell to 2.5 percent last month.
At the same time, the labor market, a component of the Fed’s monetary policy considerations, has remained remarkably resilient in the face of the Fed’s current cycle of interest rate hikes. Indeed, it has begun to show signs of slowing. The unemployment rate ticked up to 4.1 percent in June. Although unemployment remains historically low, this is the highest level of unemployment seen since October 2021.
Though monthly job growth has remained strong, it appears to be slowing. Job growth over the three months ending in June – the most recent three months for which we have relevant data – averaged roughly 177,000 per month. This is notably lower than the average three-month job gain through May (roughly 249,000 jobs) and the average three-month job gain through April (roughly 242,000 jobs). The July jobs report, to be released by the Bureau of Labor Statistics on Friday, is expected to show unemployment remaining at 4.1 percent and monthly job gains remaining considerably strong, but cooling in line with recent trends.
U.S. Unemployment Rate (June 2023 – June 2024)
Source: Federal Reserve Bank of St. Louis
One clear sign of a disruption in the labor market could be seen on Friday, with the release of the July jobs report. We are close to triggering the Sahm Rule, a recession indicator coined by former Federal Reserve economist Claudia Sahm, and new unemployment data could push the economy over the edge. The Sahm rule states that when the three-month average of the U.S. unemployment rate moves 0.5 percent or more above the three-month low point over the past twelve months, the economy may enter a recession.
But as Sahm said last week, reaching this tipping point would not necessarily indicate that recession is imminent since unusual shifts in labor supply caused by the pandemic and immigration may be leading to the Sahm rule overstating the extent to which the labor market is weakening. Importantly, Sahm also noted that the risk of recession over the coming months is elevated as she joined calls for the Fed to begin cutting rates.
Growth has also remained strong, with the American economy growing by a remarkable 2.8 percent on an annualized basis in the second quarter of this year, by 1.4 percent over the first quarter of this year, and by 2.5 percent in 2023.
Consumer Confidence Falls as Rates Remain Elevated
At this stage in the Fed’s current cycle of rate hikes, officials must be wary of the burden its elevated rates place on younger and lower-income consumers who are just starting their adult lives or struggling financially.
Consumers have become less positive about their family financial situations. The results of the July Consumer Confidence Survey released by the Conference Board yesterday showed that consumers’ assessments of their family finances have deteriorated continuously since the beginning of this year, with consumer assessments of their current family financial situation and their situation over the next six months becoming less positive since last month.
The report found that on a six-month moving average basis, purchasing plans for homes fell to a 12-year low. Higher interest rates have contributed to this by pushing mortgage rates up. The average rate on a 30-year fixed mortgage briefly exceeded eight percent, reaching a 20-year high in October, and surpassed seven percent in February. Higher mortgage rates have pushed potential first-time homebuyers to wait for a lower-rate environment.
Additionally, the report found that consumers reported planning to spend less on services last month than they had in July of last year. Consumers said over the next six months, they plan to spend less on many discretionary items, like personal travel, and purchase less expensive services, while prioritizing non-discretionary spending, including healthcare and motor vehicle services.
Consumers have also become less confident in the current labor market, with consumers’ assessment of the current labor market situation falling to its lowest level since March 2021. Chief Economist at the Conference Board, Dana Peterson, surmises that smaller monthly job gains could be weighing on consumers’ assessment of current job availability. Proportionately, last month more consumers also predicted a forthcoming recession.
The Fed Should Cut Rates in September
As FOMC officials consider beginning to cut interest rates at long last, Committee members must be mindful of balancing the Fed’s dual mandate of promoting maximum employment and stable prices. The FOMC initiated interest rate hikes as it sought to bring inflation down from its peak, but the impact of rate hikes famously has a long and variable lag. Inflation has significantly cooled and as early signs of potential weakening in the labor market emerge, officials should cut rates sooner rather than later to reduce the risk of disrupting the labor market’s surprising resilience.
The FOMC will meet three more times before the year is over – in mid-September, in early November (on the two days immediately following the 2024 general election), and in mid-December. The Fed has consistently been clear that its monetary policy decisions are independent of politics and election cycles, but a decision to cut rates for the first time this cycle is unlikely to come in November. Waiting beyond September to initiate rate cuts could allow too much time for labor market softening to persist and deepen, and allow the often difficult-to-predict lagged effects of interest rate hikes to ripple across the broader economy. An excessively long contractionary policy could risk upending the tentative soft landing the Fed has managed to put in its sight.
With inflation trending toward the Fed’s two percent target it is perhaps even past time for the FOMC to begin cutting rates from their extended peak. Committee officials must act quickly to protect the ongoing strength of the labor market and stave off the many risks associated with a high-rate environment while providing relief to consumers who remain concerned about the economy.