Ever since the Federal Reserve signalled that the rate-rising phase of its historic fight against inflation was over, attention has focused on when – and how quickly – the US central bank would provide relief to American borrowers.
Chairman Jay Powell and his colleagues have said they need irrefutable proof that inflation, which at one point hovered around a four-decade high, is retreating to the Fed’s 2 per cent target. Until then, the Federal Open Market Committee (FOMC) would lack the confidence necessary to begin lowering interest rates.
A string of favourable inflation data – coupled with signs that the labour market has lost some of its earlier heat – suggests that high bar has more or less been met.
But the top ranks at the Fed are still hesitant to declare victory just yet. Rather, they see a number of benefits in waiting a bit longer to lower their policy rate from its current 5.25-5.5 per cent level.
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Forgoing a July start allows officials to gather more good data, a threshold Mr Powell set at congressional hearings earlier this month and will be realised if Wall Street forecasts for further disinflation come to fruition. Between the July and September policy gatherings, officials will receive two sets of inflation and jobs reports along with a slew of other updates about the health of the consumer and the housing market, among other cornerstones of the world’s largest economy.
Having more conclusive evidence in hand will be critical to assuage some officials who still harbour scepticism that the coast is clear, especially in light of the unexpected inflation flare-up that occurred earlier this year.
After months of steady progress towards 2 per cent, first-quarter data showed an unwelcome resurgence in price pressures that cast doubt about the Fed’s grip on inflation and scuppered plans to begin cuts at the start of the summer
“They’ve been headfaked before, and credibility is important,” said Diane Swonk, chief economist at KPMG US.
After months of steady progress towards 2 per cent, first-quarter data showed an unwelcome resurgence in price pressures that cast doubt about the Fed’s grip on inflation and scuppered plans to begin cuts at the start of the summer. That was the latest in a series of economic surprises in the aftermath of the coronavirus pandemic in which officials were wrong-footed and forced to rethink their policy settings.
While the first three months of the year are now broadly seen as an aberration, given that price pressures swiftly abated in the second quarter, it nonetheless has made officials wary about prematurely signalling a policy pivot.
Moreover, there is still some distance between individuals about how many cuts are even necessary once that process starts, with projections published in June showing a split between one and two reductions this year.
If the door is shut to a July cut, it appears open for one in September.
Traders in fed funds futures markets have fully priced in that outcome. That meeting will be the last before the November presidential election, after which officials will gather twice more before year-end. Market participants expect at least two quarter-point cuts in 2024.
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Over the past month, Powell and his colleagues have maintained that they are growing more optimistic about the downdraft in inflation. Two of the most influential voices on the FOMC, John Williams of the New York Fed and governor Christopher Waller, lent support to that view in the week before a scheduled communications “blackout”, declaring that the central bank is getting “closer” to where it wants to be to cut.
The Fed moves like an “ocean liner”, said Julia Coronado, a former Fed economist who now runs MacroPolicy Perspectives, meaning that outside of crises, it typically avoids abrupt policy pivots. Coronado expected “clear” changes in the July policy statement that would signal a cut was imminent.
Reinforcing the case is a meaningful shift under way in the labour market. Once seen as an accelerant stoking inflation, US employment conditions have softened. Hiring is still strong, but Americans seeking a new position have fewer opportunities and more are applying for jobless benefits. Wage growth has also tailed off.
Another concern is that inflation gets ‘stuck’ above target at about 2.6 per cent or 2.7 per cent
“As of today, I see there is more upside risk to unemployment than we have seen for a long time,” said Waller in his latest public appearance, even as he warned of the prospects of “uneven” inflation data that makes a rate reduction in the near future “more uncertain”.
Another concern was that inflation gets “stuck” above target at about 2.6 per cent or 2.7 per cent, said Michael Strain, director of economic policy studies at the American Enterprise Institute, who advocates against the central bank moving in September.
Importantly, however, the Fed does not want the labour market to deteriorate further. It also maintains that getting inflation back to target need not cause excessive job losses.
“Because the labour market was so resilient, they thought they had the luxury of time to be super sure [about inflation],” said Coronado. “That luxury is fading.”
Jan Hatzius, chief economist at Goldman Sachs, has gone so far as to argue that waiting until September raises the risk of the very outcome the Fed is trying to avoid.
“If you wait, there is a risk on the economic side that you see more of a deterioration in the labour market,” he said.
“Given how much things have changed – how much inflation has come down and how much the labour market has rebalanced – why wouldn’t you just get in advance of what you’re probably going to do anyway?” – Copyright The Financial Times Limited 2024
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