Federal Reserve Chairman Jerome Powell arrives to testify before Senate Banking, Housing, and Urban Affairs Committee hearings to examine the semiannual monetary policy report to Congress on July 9, 2024, at Capitol Hill in Washington, DC.
Chris Kleponis | AFP | Getty Images
Federal Reserve officials are moving closer to their goal of low inflation at their monetary policy meeting on Tuesday, but how much they will cut interest rates remains an open question.
A week's inflation data showed that price pressures have eased significantly since their meteoric rise in 2021-22. A consumer price indicator showed that 12-month inflation hit its lowest level since February 2021, while wholesale price indicators suggested that pipeline price increases are mostly under control.
Both values were certainly enough to clear the way for an interest rate cut at the meeting of the Federal Open Market Committee of the US Federal Reserve. The meeting ends on Wednesday with an interest rate decision and an updated forecast of future developments by the central bankers.
“We have two more months of good inflation data since the last Fed meeting,” Claudia Sahm, chief economist at New Century Advisors, said in a CNBC interview on Friday. “That's what the Fed has been asking for.”
The question now, however, is how aggressive the Fed should be. Financial markets, which serve as a guide to the central bank's direction, have been no help.
Futures markets had focused on a quarter-percent, or 25 basis point, rate cut for much of the past week, but that changed on Friday: According to CME Group's FedWatch tool, traders believed the probability of a cut of either 25, half a percent or 50 basis points was almost equal.
Sahm is among those who believe the Fed must mobilize its forces.
The inflation data “alone would have given us 25 percent next week, as it should, and will give us a whole series of cuts after that,” she said. “The benchmark rate has been above 5 percent, it's been set for over a year to fight inflation. That battle has been won. They need to start getting out of the way.”
According to Sahm, this means starting with a reduction of 50 basis points in order to set a lower limit for a possible decline in the labor market.
“The labour market [since] “July last year has been weaker,” she said. “So it's about recalibrating. We have more information. [Fed officials] We need to sort this out somehow, make a 50 basis point cut and then be ready to do more.”
Confidence in inflation
Inflation reports suggest that while the battle to bring inflation back to 2 percent is not quite over, things are at least moving in the right direction.
The consumer price index for all goods rose by just 0.2 percent in August, bringing the inflation rate for the full year to 2.5 percent. Excluding food and energy, core inflation was 3.2 percent, well below the Fed's target.
But most of the strength comes from stubbornly high housing costs, which are exacerbated by the Bureau of Labor Statistics' complicated “owner equivalent rent” measure, which asks homeowners what they could get if they rented out their homes. The measure, which makes up about 27 percent of the overall consumer price index, is up 5.4 percent from a year ago.
Despite the ongoing pressure, consumer surveys suggest inflation has been subdued, if not stopped entirely. Respondents to a University of Michigan survey in September expected inflation to reach 2.7% over the next 12 months – the lowest since December 2020.
Taking into account all the different inflation dynamics, Fed Chairman Jerome Powell said at the end of August that his “confidence had grown” that inflation was heading back toward the two percent mark.
That leaves employment. Powell said in the same speech he gave at the Fed's annual meeting in Jackson Hole, Wyoming, that the Fed “does not seek or welcome a further slowdown in the labor market.”
The Fed has two missions – stable prices and a healthy labor market – and its primary mission appears to be about to change.
“If Powell wants to keep his promise that 'we don't want another slowdown, another cooling,' then they really have to do something because this cooling trend is well established,” Sahm said. “As long as it is not interrupted, we will continue to see payrolls and [the] The unemployment rate is rising.”
The case for a quarter
There are certainly significant voices hoping that the Fed will only cut interest rates by a quarter of a percentage point at its meeting next week. This reflects that the central bank has more work to do on inflation and is not overly concerned about the labor market or a broader economic slowdown.
“That's the real key thing they need to focus on: normalizing their policies and not trying to accommodate an economy that is really in trouble,” said Tom Simons, U.S. economist at Jefferies. “I think they've made that point very well so far.”
Even with the quarter-point move predicted by Simons, the Fed would still have plenty of room for further action later.
In fact, market prices suggest that interest rates could fall by 1.25 percentage points by the end of 2024. This is an indication of the urgency of reducing benchmark interest rates from their highest level in more than 23 years – currently 5.25 to 5.50 percent.
“The only reason they were so cautious about cutting is that they were worried that inflation would rise again,” Simons said. “Now they have more confidence, based on data that suggests [inflation] is not coming back at the moment. But they have to be very careful and keep an eye on the potentially changed dynamics.”
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