Fed Speak – Jerome Powell says, more rate cuts to come

2 Oct 2024 , 08:44 PM

FED SPEAK – JEROME POWELL HINTS AT MORE RATE CUTS

In the aftermath of the Monetary Policy statement by the Fed, and prior to the presentation of the minutes, the Fed Speak assumes a lot of importance. The macro cues are not only taken from the Fed statement and the minutes but also the speeches given in the interim period by the key functionaries of the FOMC. On Monday, Fed Chair, Jerome Powell addressed the National Association for Business Economics (NABE) Annual Meeting, Nashville, Tennessee; wherein he laid out his broad monetary stance and how he sees the rates panning out. Powell once again emphasized that the Fed would be flexible.

Powell was cautious enough to add that any action would be data driven and there was no set path for rates to traverse. However, he also hinted that the time for hawkishness was over and it was time to reflect on how to ensure full employment and prevent a slowdown in the economy (hard landing). That clearly called for a relatively dovish approach. The two data points that came out after the Fed statement were broadly supportive of the views expressed by Jerome Powell. The third estimate of US Q2 GDP came in at 3.0%, while the PCE inflation for August was sharply lower by 30 bps at 2.2%.

RECAP OF WHAT THE FED STATEMENT HAD SAID

In the recently concluded Fed meeting on September 18, 2024. The Fed had clearly underlined the need to shift focus more on full employment. The rate of unemployment had spiked to 4.3% and 4.2% in the months of July and August and the September unemployment data which will be out this Friday, is also expected to be around 4.2%. Addressing the NABE, Jerome Powell underlined that the time had come for the Fed to move decisively towards lower rates and, probably, front-load such rate cuts.

However, he also added that the timing and the trajectory of rates would depend on the incoming data pertaining to PCE inflation, GDP growth and unemployment data. Explaining the 50 bps rate cut in September, Powell emphasized that the US economy had made significant progress on the economic growth front and the risk of hard landing may not be as grave as was originally imagined. However, the gist of Powell’s speech was that the time was ripe to shift focus from price stability to full employment, a goal which had been relegated to the background in recent months. That had to undergo a shift.

JEROME POWELL’S TAKE ON THE LABOUR MARKET

In the last few quarters, Fed was facing a dilemma between jobs and inflation. Lower inflation mandated that the unemployment could not be around 3.5% and the wage growth had to slow down. However, such a development also risked a hard landing for the US economy. However, in the last few months, according to Powell, the normal process of adjustment of inflation and jobs had done the job for the Fed. As Powell underlined in his speech, unemployment rate was well within the range of estimates of its natural rate. While fresh recruitments may be low, even the layoffs were few and far between. More importantly, the unemployment rate may be slightly overstated because the labour force participation rate of individuals aged 25 to 54 (so-called prime age) is near its historic high and there has been a huge influx of immigrant labourers into the labour force seeking jobs.

The other side of the job market is the wages and economists had been projecting that the wage growth was too strong to be able to really control inflation. That has changed in the last few months with wage growth moderating. However, with inflation falling to close to 2% levels, the real wage growth continues to be strong. More importantly, the growth in real wages is being matched by productivity gains, so there is no risk of inflation caused by a mismatch between wage growth and productivity in the US economy. More importantly, the ratio of job openings to unemployed workers has moved down steadily but remains a shade over 1. It implies that there are still more open positions than there are people seeking work. This is in sharp contrast to the pre-COVID period.

As Powell has rightly said, the sync between a higher level of unemployment and lower inflation had been an issue but that has come about automatically. The net result is that the labour market conditions had clearly and decisively cooled over the last one year. Workers now view jobs as somewhat less available than in the pre-COVID period, which is a positive takeaway. Explaining the 4.2% unemployment, Powell is of the view that the moderation in job growth and the increase in labour supply combined to raise the unemployment rate to spike by 4.2% in August 2024. What is more relevant is the statement by Jerome Powell that he did not see the need for more cooling in labour market conditions for 2% inflation.

JEROME POWELL’S TAKE ON INFLATION

According to Powell, the latest private consumption expenditure (PCE) inflation announced late last month is quite instructive. The headline inflation at 2.2% shows how much inflation has traversed while the core PCE inflation at 2.7% highlights the risk factor. However, the good news is that disinflation has been broad based, and recent data indicate further progress toward a return to 2% inflation on a sustained basis. However, bounce in core inflation by 30 bps in the last 2 months is largely on the back of higher than expected housing inflation. While housing inflation has also been falling, it has not been of the same magnitude. However, if housing was excluded, the core sector inflation was also very close to the pre-pandemic levels. On a comparison of the labour market and the inflation story, one can conclude (according to Powell) that labour market is now roughly in balance. In other words, the longer-run inflation expectations remain well anchored and the inflation expectations are also well within the limits only.

FINAL WORD – WHAT THE DATA MEANS FOR MONETARY POLICY

According to Powell, the monetary policy colour would still be data driven. However, there is a lot more stability and predictability in the US macros, that about a year or two years back. Here is how the monetary policy in the US could evolve in the coming months.

• The good news, according to Powell, has been that the last one year saw healthy gains in the labour force and productivity. As Powell has said time and again, the goal of the Fed continues to be restoring price stability without the kind of painful rise in unemployment that has frequently accompanied efforts to bring down high inflation rapidly. According to Powell, high inflation hits the vulnerable families the most. By solving the inflation problem and giving them the unemployment problem, it would still take its toll on the most vulnerable sections of the American society. Hence, the delicate balance was the need of monetary policy. As Powell himself admits; that task is far from completed; but then good deal of progress has been made toward that outcome.
• Since late 2021, when high inflation first reared its ugly head, the level of PCE inflation ran well above the Fed goal. At the same time, the labour market was extremely tight with demand far exceeding supply. That limited the effectiveness of many of the anti-inflation measures mooted by the Fed. Here, Powell has pointed to the fact  that keeping the monetary policy restrictive had helped the Fed in restoring the balance between overall supply and demand in the economy. As a result, the risks to achieving the employment and inflation goals of the Federal Reserve are roughly in balance.
• Explaining the rather long 14-month pause since July 2023, Powell underscored that there was a reason for keeping the policy rate at a 20-year high for a full 14 months. Till recently, the core inflation was above 4% unemployment was 3.5%. That is a 50-year low unemployment and a level that is defined as full employment by the Fed. Since July 2023, the inflation rate had moved decisively lower and the unemployment rate had moved up from 3.4% to 4.3%. That turning of tables called for an urgent recalibration of policy stance to reflect tangible progress toward the Fed goals as well as the changed balance of risks. That shift explained the decision to front-load rate cuts.
• To sum up, the Fed decision to reduce policy rates by 50 basis points reflects a senser of growing confidence that the time was ripe for recalibration of policy. The conviction at this juncture is that an appropriate recalibration of policy stance can ensure that price stability and full employment can be maintained at the same time.

However, Powell did not commit on when they would shift the stance of the policy to neutral. The only thing Powell mentioned in his speech was that if the US economy evolved as expected, then the stance of the monetary policy would move toward a more neutral stance. However, the shift would be gradual and well deliberated. Jerome Powell’s closing remark, probably, said it all; “Overall, the US economy is in solid shape and we intend to use our tools to keep it there.”