Federal Reserve Chairman Jerome Powell has unveiled his latest buzzword to describe monetary policy, with policy “recalibrated” at a pivotal moment for the central bank.
In his post-FOMC press conference on Wednesday, Powell used variations of the word no fewer than eight times, as he tried to explain why the Fed took the unusual step of cutting interest rates by a half-percentage point in the absence of clear economic weakness.
“Recalibrating our policy stance will help maintain the strength of the economy and labor market, and will continue to enable further progress on inflation as we begin the process of moving forward to a more neutral stance,” Powell said.
Financial markets were not entirely sure how to take the message from the committee chairman in the immediate aftermath of the meeting.
But asset prices rose on Thursday as investors took Powell at his word that the unusual move was not a response to a major slowdown in the economy. Rather, it was an opportunity to “reset” Fed policy away from a strict focus on inflation to a broader effort to ensure that recent weakness in the labor market doesn’t spiral out of control.
The Dow Jones Industrial Average and the S&P 500 jumped to new record highs during trading on Thursday after violent volatility on Wednesday.
“The policy was designed to achieve meaningfully higher inflation,” said Tom Porcelli, chief U.S. economist at PGIM Fixed Income. “With inflation now approaching target, the Fed can remove some of the aggressive tightening it has imposed.”
“It really allows him to push this narrative that this easing cycle is not about us going into a recession, it's about extending the economic expansion. I think that's a really powerful idea. It's something we were hoping he would do,” he added.
Powell's buzzwords
Many of Powell's previous attempts to offer dramatic descriptions of the Fed's policy or his views on the economy have not gone well.
In 2018, his descriptions of efforts to reduce the Fed’s bond holdings as “on autopilot,” as well as his assessment that a series of interest rate hikes that year had brought the Fed “a long way” from the neutral interest rate, drew negative market reactions.
Most famously, his insistence that the rise in inflation in 2021 would prove to be “transitory” ultimately led the Fed to slow its policy implementation to the point where it had to enact a series of three-quarter-percentage-point interest rate hikes to bring inflation down.
But markets expressed confidence in Powell's latest assessment, despite that record and some signs of cracks in the economy.
“In other contexts, a larger move might convey greater concern about growth, but Powell has repeatedly emphasized that this was essentially a cheery cut because falling inflation allows the Fed to act to maintain a strong labor market,” Michael Feroli, chief U.S. economist at JPMorgan Chase, said in a note to clients. “Moreover, if policy is optimally positioned, it should return the economy to a favorable place over time.”
Feroli still expects the Fed to follow up Wednesday's move with a similarly sized move at its Nov. 6-7 meeting unless the labor market reverses the slowdown that began in April.
There was some good news on the jobs front on Thursday, as the Labor Department reported that weekly unemployment claims fell to 219,000, the lowest level since May.
unusual downward movement
The half-percentage-point — or 50 basis points — cut was notable in that it marked the first time the Fed had exceeded its traditional moves by a quarter point in the absence of an imminent recession or crisis.
Although Powell did not buy the idea that the move was a make-up for not cutting rates at the July meeting, speculation on Wall Street suggested that the central bank was indeed playing catch-up to some extent.
“He probably felt they were delaying a little bit,” said Dan North, senior North America economist at Allianz Trade. “A 50 basis point rate cut is unusual. It’s been a long time coming, and I think the last labor market report may have been the reason for his hesitation.”
Indeed, Powell has made no secret of his concerns about the labor market, saying on Wednesday that addressing potential weakness was an important driver behind the recalibration.
“The Fed still sees the economy as healthy and the labor market strong, but Powell has signaled that it is time to recalibrate policy,” wrote Seth Carpenter, chief global economist at Morgan Stanley. “Powell has confirmed and demonstrated through his rate cut that the FOMC is prepared to move gradually or take larger steps depending on incoming data and evolving risks.”
Carpenter is among a group that expects the Fed to now be able to taper its monetary easing program to quarter-point increases over the rest of this year and into the first half of 2025.
However, futures traders are pricing in a more aggressive pace that would entail a quarter-point cut in November, but a return to a half-point move in December, according to CME Group’s FedWatch gauge.
Bank of America economist Aditya Bhave pointed to a change in the Fed's post-meeting statement that included a reference to seeking “maximum employment,” which he saw as a signal that the central bank is prepared to remain aggressive if the jobs picture continues to deteriorate.
This also means that recalibration can become difficult.
“We believe the Fed will end up cutting rates more aggressively than it has indicated,” Bhave said in a note. “The labor market is likely to remain subdued, and we think markets will push for another massive rate cut in Q4.”
