U.S. Federal Reserve Chairman Jerome Powell arrives to testify before the Senate Banking, Housing and Urban Affairs hearings to examine the semiannual monetary policy report submitted to Congress at the Capitol in Washington, D.C., July 9, 2024.
Chris Kleponis | AFP | Getty Images
Federal Reserve officials head into their policy meeting on Tuesday closer to their goal of low inflation, but how much they will ease interest rates remains an open question.
Inflation data over the past week showed that price pressures have eased significantly since their massive surge in 2021-22. A measure of consumer prices showed 12-month inflation at its lowest since February 2021, while wholesale price gauges suggested that pipeline price increases were mostly under control.
The two readings were certainly enough to pave the way for a rate cut at the Federal Open Market Committee meeting, which concludes on Wednesday with a decision on interest rates and updated forecasts on how central bankers view things going forward.
“We’ve had another two months of good inflation data” since the Fed’s last meeting, Claudia Sahm, chief economist at New Century Advisors, said in an interview with CNBC on Friday. “That’s what the Fed asked for.”
But the question now turns to how aggressive the Fed should be. Financial markets, which provide a guide to where the central bank is headed, have not been helpful.
Futures markets had been pricing in a quarter-point, or 25 basis point, rate cut for most of last week. But that changed on Friday, with traders shifting to roughly even odds of a 25-, half-point, or 50 basis point rate cut, according to CME Group’s FedWatch tool.
Sahm is among those who believe the Fed should move to a larger size.
“The inflation data alone was enough to get us to 25% next week, as it should be, and it will get us a whole series of cuts after that,” she said. “The federal funds rate has been above 5%, and it’s been there for over a year to fight inflation. They’ve won that fight. They need to start clearing the way.”
This means, Sahm said, starting with a 50 basis point cut as a way to put a floor under the potential deterioration in the labor market.
“The labor market has been weaker (since) last July,” she said. “So there is an aspect of recalibration. We’ve gotten some additional information. (Fed officials need to) kind of clean up, do a 50 basis point cut and then be prepared to do more.”
Confidence about inflation
Inflation reports suggest that the battle to get inflation back to 2% is not over yet, but things are at least moving in the right direction.
The consumer price index for all goods rose just 0.2% in August, bringing the full-year inflation rate to 2.5%. Excluding food and energy, core inflation was 3.2%, well below the Fed’s target.
But much of the underlying strength came from persistently high housing costs, boosted by the Bureau of Labor Statistics’ “homeowner equivalent rents” measure, which asks homeowners how much they would earn if they rented out their homes. The measure, which accounts for about 27 percent of the CPI’s total weight, rose 5.4 percent from a year ago.
Despite the ongoing pressures, consumer surveys suggest confidence that inflation has been subdued if not completely halted. Respondents to a University of Michigan survey in September expected inflation to be 2.7% over the next 12 months, the lowest level since December 2020.
Taking into account all the different inflation dynamics, Federal Reserve Chairman Jerome Powell said in late August that his “confidence has grown” that inflation is heading back toward 2%.
That leaves the question of employment. In the same speech at the Fed’s annual meeting in Jackson Hole, Wyoming, Powell said the Fed “neither seeks nor welcomes further slowdowns in labor market conditions.”
The Fed has two missions—stable prices and a healthy labor market—and its core mission appears to be about to change.
“If Powell is going to deliver on his promise, ‘We don’t want more weakness, we don’t want more slowdown,’ they’re going to have to really move here, because this slowdown is well established,” Sahm said. “Until it’s broken, we’re going to continue to see payrolls decline and unemployment rise.”
Quarter case
There is certainly a strong bias toward the Fed cutting interest rates by just a quarter of a percentage point at next week’s meeting, reflecting that the central bank still has more work to do on inflation and is not overly concerned about the labor market or the broader economic slowdown.
“That’s the key thing they really need to focus on, is normalizing policy and not trying to provide accommodation to an economy that’s really in trouble,” said Tom Simons, a US economist at Jefferies. “I think they’ve done a very good job of articulating that view so far.”
Even with a quarter-point move, which Simons expects, the Fed will have plenty of room to do more later.
In fact, market pricing expects rates to fall by 1.25 percentage points by the end of 2024, a sign of urgency in cutting benchmark borrowing costs from their highest levels — currently 5.25% to 5.50% — in more than 23 years.
“The whole reason they were so cautious about cutting rates was because they were worried about inflation returning,” Simons said. “Now they have more confidence based on the data that inflation is not coming back now. But they need to be very careful about monitoring the potential changing dynamics.”
