At its July 31 meeting, the Fed sought to communicate a more balanced assessment of risks to include labor market deceleration. Powell signaled an imminent policy easing program.
4 AUG 2024
Edward von der Schmidt
FOMC Recap: A Balancing Act
The Federal Open Market Committee (1) voted unanimously to maintain policy rates at elevated levels (Federal Funds Target Rate: 5.25-5.50%) (2). Officials discussed easing but sought more time and additional confidence in inflation gauges pointing to moderating price pressures. Provided that inflation does not materially accelerate and remains only “somewhat elevated”, the Fed intends to begin easing by cutting rates at least 25 basis points (25bp or 0.25%) as soon as September. The more balanced assessment at the end of July is a precursor to more accommodative policy in the Fall.
The Chair acknowledged shifting risks and an uncertain outlook with respect to the Fed’s dual mandate to foster an environment of price stability and maximum employment. After more than two years of above-target inflation owing to post-pandemic supply imbalances and prior accommodation, tolerable inflation readings have dovetailed with signs that the labor market is far from overheating. Current employment conditions now call for a less restrictive posture. Unexpected demand and domestic labor resilience had bolstered the US economy as monetary policy was tightened to temper inflation. The Fed is now wary of policy lags, however, amid signs of decelerating prices and activity as well as “normalizing” employment conditions.
Powell did not explicitly commit to any policy action or forward guidance, stressing that the central bank would continue to evaluate a “totality” of available information. He added that policymakers would not be swayed by any report in isolation. He appeared comfortable signaling a September start to multiple rate cuts – assuming inflation does not come in alarmingly high. He confirmed there was no consideration of moving half a point (50bp, 0.50%) in July. The decision before the Fed will be whether to begin the cycle by cutting 25bp (0.25%) at each meeting (e.g., September 18, November 7, December 18) or every other (September 18, December 18).
The Fed’s preference will be to foster expectations of an orderly easing cadence consistent with its meeting schedule and avoid the uncertainty introduced by more discretionary responses. If employment surveys disappoint, downside economic risks from softening labor markets suggest that the Fed will be inclined to cut policy rates at least 25bp every 7-8 weeks and signal accordingly. Perhaps only if inflation is stubborn (3% or higher) will the Fed pause until November. The Fed is shifting toward accommodative rhetoric to prepare markets in anticipation of an easing cycle.
Takeaways
The Fed acknowledged that its current monetary policy stance is restrictive and will need to change, most likely beginning with its September 18, 2024 FOMC decision.
The Chair telegraphed a September policy rate cut of 25bp (0.25%) - but did not commit
Provided that preferred year-over-year (y/y) inflation gauges remain in the 2.5-2.6% area or lower, forward guidance on pacing will be the next set of signals to look out for
Powell also introduced the notion of rate cuts (plural) to prepare for an easing program
The Fed has recently preferred semi-automated adjustments; they would ideally like to move target ranges by 25bp at each or every other meeting during a normalization cycle
Chair Powell acknowledged that the Committee seriously deliberated a 25bp policy rate reduction in July but unanimously agreed to wait
The Fed held off on cutting rates in order to gain additional confidence in inflationary trends that had prevailed for only a quarter (three months)
The critical Fed debate will not be whether to move between meetings (saved for
perceived emergencies only), but rather how frequently to cut beginning in September, assuming that observed inflation is well-behaved until then
If incoming inflation data remains acceptable, deterioration in labor market conditions will skew monetary policy toward faster normalization, or at least 25bp interest rate cuts at every meeting until a future slowing or pause
With the Fed oriented toward unwinding restrictive policy in September, near-term inflation readings will be weighed against leading and contemporaneous labor market data to ascertain the likely pace of cuts
The Fed has dueling mandates – elevated inflation weighed against softening labor markets.
Had it not been for insufficient data to assuage price concerns, the Fed would have cut 25bp in July on account of current labor market conditions
Inflation has appeared to moderate to an acceptable albeit “somewhat elevated” pace for a full quarter, not enough time for the Committee to be comfortable assessing a trend. The decision to hold off on a rate cut until September stems from this prudence
The statement reiterated that the “Committee is strongly committed to returning inflation to its 2 percent objective”
Powell opined that supply-driven inflation in the pandemic’s wake had largely run its course, but the Chair’s reluctance to declare victory over sustained, above-target inflation in recent years suggests that the Fed is not willing to look past inflation objectives
In light of labor market conditions and economic uncertainty, the Fed acknowledged that its stance must change and all but formally announced an imminent easing cycle
The Fed will begin easing to accommodate its employment mandate, but its pace will be determined in part by how observed inflation readings evolve toward target
The Fed does not want to introduce uncertainty through its forward guidance – a tool in its own right – but will prefer to unambiguously signal an orderly “normalization process”
Clear intentions of steady easing in manageable increments will be viewed as inflation- appropriate and sufficiently accommodative, particularly via more predictable transmission to intermediate rates
Having presided over a unanimous vote to hold off on cutting rates in July, the Chair made it very clear that a 50bp cut to begin easing was not contemplated at this meeting
Larger-than-signaled adjustments could amplify policy uncertainty in a manner that could tighten financial conditions, contrary to the Fed’s goals
If the Fed planned to cut 50bp at the next meeting, Powell would not have dismissed the possibility so readily in the press conference; 25bp per meeting must be preferable
The most likely accommodative guidance given labor weakness and suitable inflation will be to signal an intention to reduce target rates another 25bp each meeting for the immediate future (out to one year)
The quarterly Statement of Economic Projections (SEP) to be released along with the September statement will reflect officials’ best predictions for the likely evolution of policy rates given prevailing conditions and forecast assumptions, but the most important expectations will be those that Powell himself chooses to communicate
As always, the Fed will remain data-dependent and adjust its policy stance and guidance as conditions evolve – they reserve the right to move at their discretion
Notes
The Fed Chair expected that other central banks would begin to ease in a global lifting of
restrictive monetary policy
The Bank of England began cutting policy rates on August 1 after a split vote
The relative magnitude and pace of monetary easing will bear implications for interest rate, inflation, and currency differentials along with associated volatility
The Fed will not be swayed by any one report, including disappointing monthly jobs data
released Friday – totality means taking everything together over time
The data-dependent Fed is not entirely comfortable with seasonality models and adjustments
Powell prefers annual over monthly or quarterly measures to reduce noise
The Chair cautioned against looking at historical precedents too closely for comparison,
saying “history doesn’t repeat itself, it rhymes”
The Fed is looking closely at private demand figures and places particular value on district-level feedback
There are currently no plans for nor is there active progress toward a Central Bank Digital Currency (CBDC)
Cryptocurrency market infrastructure and legitimacy would presumably benefit from the introduction of digital fiat collateral or cash, but this is nowhere on the horizon in the US
No specific geopolitical considerations were highlighted – these risks may be encapsulated by “economic uncertainty”
The FOMC is comprised of permanent and rotating voters among the Federal Reserve Board of Governors in addition to the President of the Federal Reserve Bank of New York and other regional Bank Presidents.
This range is the target cost of borrowing reserve funds held at the Fed overnight among banks and eligible institutions. Most market and discount rates are ultimately based on this or similar policy benchmarks, with the incorporation of a premium or spread to compensate for non-sovereign risks over time.
This is not financial advice and should not be taken as such. The observations and opinions expressed here are protected by copyright and belong to Datum Research LLC. All rights reserved.