Federal Reserve Chairman Jerome Powell arrives for a press conference following a meeting of the Federal Open Market Committee at the William McChesney Martin Jr. Federal Reserve Board Building in Washington, DC on July 31, 2024.
Andrew Harnik |
As the US Federal Reserve now paves the way for interest rate cuts, some parts of the market can hardly wait for dinner to finally be served.
“What do they want?” Claudia Sahm, chief economist at New Century Advisors, asked on CNBC shortly after the Fed concluded its meeting on Wednesday. “The bar is being set pretty high, and that really doesn't make a lot of sense. The Fed needs to gradually normalize this process, which means gradually lowering interest rates.”
Sahm is known for formulating the Sahm Rule, which uses changes in the inflation rate as a measure of recessions. He has been a vocal advocate for the central bank to loosen monetary policy to prevent the economy from entering a recession. The rule states that the economy is in a recession when the three-month average of the unemployment rate is half a percentage point above its 12-month low.
With unemployment at 4.1%, the rule is just a stone's throw away, and Sahm said the Fed's insistence on keeping short-term interest rates at their highest level in 23 years is putting the economy at risk.
“We don't need a weak economy to avoid that last bit of inflation,” she said. “We don't need to be afraid of a good economy. If the inflation control is complete or we're on that glide path, it's OK, the Fed can start to pull back.”
When Fed Chairman Jerome Powell was asked about the Sahm rule during his post-meeting press conference, he spoke of a “statistical regularity” that, however, does not necessarily apply this time, as employment remains good and the pace of wage growth is slowing.
“It looks like a normalization of the labor market, job creation and a fairly decent wage level, which is increasing sharply but gradually coming down,” he said. “If it turns out to be more than that, we are well placed to respond.”
Cautious approach
However, markets are factoring in aggressive interest rate cuts, starting with a quarter-percentage point cut in September. This would be the first cut since the beginning of the Covid crisis.
After that, the markets are expecting interest rate cuts in November and December. According to the indicator for 30-day Fed Funds futures contracts compiled by the CME Group, a cut in the key interest rate by a full percentage point by the end of the year is attributed a probability of about 11 percent.
Rather than taking its foot off the brake, the Fed said on Wednesday it would keep its overnight interest rate in a range of 5.25 percent to 5.50 percent. While the post-meeting statement pointed to progress on inflation, it also reiterated that policymakers on the Fed's rate-setting Open Market Committee need “more confidence” that inflation is heading back toward 2 percent before they are willing to cut rates.
Jeffrey Gundlach, CEO of DoubleLine, also believes that the Fed is risking a recession with its tough interest rate policy.
“That's exactly what I think, because I've been around this for over 40 years and it seems to happen every time,” Gundlach told CNBC's Scott Wapner on “Closing Bell” on Wednesday. “All the other underlying aspects of the employment data are not improving. They're getting worse. And once they hit that upper limit where they have to start cutting rates, it's going to cost more than they think.”
In fact, he believes the Fed could cut rates by 1.5 percentage points over the next year, a more aggressive pace than policymakers envisioned in the last update to their “dot plot” of individual forecasts.
Gundlach assumes that the consumer price index will soon be below 3%, which will make real interest rates or the difference to the Fed funds rate particularly high.
“When you have a positive real interest rate of one and a half percent, that means you have 150 basis points of room to cut rates without even thinking you're overdoing it,” he said. “I think they should have cut rates today, quite frankly.”
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