For more than two years, inflation has eclipsed everything else at the Federal Reserve. In a shift eagerly awaited by global markets, that’s poised to change.
US central bankers are ready to cut interest rates in September amid growing confidence that price stability is within sight – while risks to the labor market have grown. They’ve laid the groundwork for the coming move in speeches over recent weeks, and Chair Jerome Powell will likely flag it more explicitly after a policy meeting on July 30-31.
It’s not quite a done deal. Fed officials still want to see monthly price numbers continuing to trend down toward their 2% annual inflation goal before they commit to lowering borrowing costs from a two-decade high. But Powell and his colleagues are also determined not to squander the chance of sticking a soft landing for the US economy, which is showing at least a few signs of losing steam.
“It’s not just about getting inflation down,” Powell told House lawmakers on July 10. “We need to be mindful of where the labor market is.”
The Fed’s preferred inflation gauge has eased to 2.6%, and the once overheated labor market has cooled to pre-pandemic levels. While officials continue to describe the labor market as strong, they have also said it may be nearing a turning point, with a steady decline in vacancies and a gradual pickup in unemployment.
“I do believe we are getting closer to the time when a cut in the policy rate is warranted,” Fed Governor Christopher Waller said Wednesday. The labor market is in a “sweet spot,” he said, but the Fed needs to keep it there.
“There is more upside risk to unemployment than we have seen for a long time,” he added.
Most officials have stopped short of saying when the first cut will likely happen, but economists and investors have interpreted their comments as signaling a September move.
“There is strong momentum within the committee to lower rates in September,” said Jonathan Pingle, chief US economist for UBS Group AG. “You are seeing cooling in a lot of areas of the labor market where there has been strength.”
San Francisco Fed President Mary Daly said in an interview that cracks in the job market are not so severe that they require immediate action. Still, policymakers acknowledge that things can turn fast.
“We don’t want to be to a point where we start to see the labor market weaken substantially — to falter — because by then, it is actually often too late to bring it back,” Daly said.
The number of job openings to unemployed workers, which hit a record high in the post-Covid period, has fallen back to 2019 levels. Hiring, while still solid, has slowed and become more concentrated in a handful of industries.
The jobless rate has climbed in each of the past three months and reached 4.1% in June — still historically low, but the highest since 2021 — and wage gains have slowed. Fed Governor Lisa Cook, speaking July 10, said the Fed is “very attentive” to the unemployment rate and would be “responsive” if it worsened.
Consumer Slowdown
The rebalancing in the labor market has been accompanied by a moderation in consumer spending, as high prices and borrowing costs weigh on Americans.
In the Fed’s latest Beige Book — which compiles observations of business conditions across the central bank’s 12 districts — almost half of the regions reported flat or declining economic activity. Looking ahead, firms’ expectations were for slower growth.
While officials continue to emphasize that policy will be guided by the totality of incoming data, they are aware that just maintaining their current stance amid easing inflation is, in effect, a form of tightening.
“If you’re going to tighten, you should make sure you’re tightening by choice, not by default,” said Austan Goolsbee, Chicago Fed president, in an interview.
The string of recent inflation readings — which have been described by policymakers in terms ranging from “encouraging” to “very good” — has bolstered the Fed’s belief that prices are on the right trajectory. Powell said earlier this week that data from the last quarter “do add somewhat to confidence.”
Policymakers have also made sure to emphasize that more information is needed before the big decision to cut rates.
“We’re actually going to learn a lot between July and September,” New York Fed President John Williams said in a Wall Street Journal interview published Wednesday.
Election Question
Investors already see a rate cut in September as a near certainty. Since the end of last month, yields on two-year Treasuries — which are sensitive to Fed policy — have plunged about 30 basis points.
Early communication from Fed officials could also help make the case to the public — an important task given the fraught politics of reducing borrowing costs less than two months before a presidential election.
In an interview with Bloomberg Businessweek, Republican candidate and former President Donald Trump said the Fed shouldn’t cut rates prior to the election. Senator Kevin Cramer, a North Dakota Republican, has said any policy moves before November could create a “bad perception.”
“The risk now is that they cause a real slowdown in the labor market,” said Stephanie Roth, chief economist at Wolfe Research. “Because there is political concern, they want to get that message out there.”
When they’re asked how the presidential contest could impact the timing of rate cuts, Fed officials emphasize that the central bank stays out of politics. The Fed even included a special-focus section on the importance of independence and transparency in its semi-annual report to Congress earlier this month.
The message from Powell and his colleagues is that the Fed will ignore the election timetable and do what’s best for the economy.
“It’s really time to have both of our dual mandates squarely in our mind,” Daly said. “We have to watch both of them as we do the risk management of how we get to a place where we have both sustainable price stability and full employment.”