By Jeanette Garretty, Chief Economist
The Federal Open Market Committee (FOMC) announced a cut in the Federal Funds target rate by 50 bps to a target range of 4.75%-5.0%. At the same time, the FOMC announcement emphasized the continuing strength of the US economy, as well as the fact that while inflation has cooled considerably, it still “remains somewhat elevated.” Indeed, the Summary of Economic Projections (SEP) released concurrently with the FOMC statement shows very little change in the economic projections from the last SEP, released in June. The only way to read this is that the FOMC should have cut interest rates by 25 bps (a far more typically sized monetary policy move) in July and is now playing catch-up. It is highly likely that the fundamental difference between the July and September meetings is a greater consensus among FOMC members today over the character of both economic growth and inflation. Going into the July meeting, there were still voices arguing against any cut in interest rates that might be “premature”; presumably, those voices have, for good or bad, now been silenced.
For those who occasionally speculate about the political independence of the Federal Reserve, this decision could possibly fuel both sides of the debate. Some may argue that the Fed has done what it should, irrespective of the forth-coming election, while others may charge that the Fed has explicitly waded into partisanship. From a completely non-political standpoint, this economist believes this was the appropriate decision because the author is on record as believing that the cuts should have started in July, given the reasonable outlook for economic growth and inflationary pressures. The failure to rely on forecasting and the heavy dependence on non-forward looking data (“data driven’) has placed the Federal Reserve in the position of adjusting monetary policy rapidly to a more appropriate— more “neutral”— stance.
Note that the FOMC statement also indicated it would continue to reduce the size of the Fed balance sheet, an action which means monetary policy will remain modestly restrictive. When asked about the contrast between an easing of policy through interest rates and the continued tightening implied by the asset sales, Chairman Powell explained in the press conference that these actions should all be seen as a “normalization,” a “return to normal.” Note that this is not how monetarists think, nor how an economist would normally communicate monetary policy changes. “Normal” in monetary policy is not a word commonly used because of its association with a static concept, e.g. normal body temperature of 98.6 or normal rainfall for the month of October. Monetarists think entirely in terms of the appropriate monetary policy, including the appropriate supply of money, for a particular economy. Since there is no “normal” state for an ever-changing, growing economy, there is no “normal” monetary policy or interest rate. Of course, few have used the word “monetarist” to describe this particular Federal Reserve.
The press conference got off to a quick start with a question about the size of this cut, the concern many have about the labor market, and the size of future cuts. Despite the FOMC statement about economic strength, Chairman Powell immediately revealed that the labor market numbers had, in fact, become an issue. It is very unclear whether Chairman Powell realized that he was being more supportive of the anxieties of investors about the economy than the FOMC statement (or the SEP.)
“We had a good discussion” about the size of the interest rate cut, said Powell. “Excellent diversity of opinion.” (one of his great talents is keeping a completely straight face at times like this.) However, he pointed out that the September SEP reveals great unanimity about the interest rate direction, i.e., the necessary changes in monetary policy. This unanimity did not exist in June/July.
Contrasting somewhat with his answer to the opening question of the press conference, Chairman Powell emphasized the strong condition of the labor market. He may have been interested in clarifying any earlier unintended negatives, and he took the opportunity to do so numerous times during the press conference. Revealing concerns about the labor market would imply that the Fed was “behind” in taking action, which is something he clearly wished to reject. “The time to support the labor market is when the labor market is strong”; interesting, not necessarily invalid, but quite a tightrope walk.
Nick Timiraos (WSJ) asked the “catch-up” question that so many were thinking about. Chairman Powell responded by saying that the Fed “is NOT behind’ (see immediately preceding paragraph) and has no intention of falling behind, thus the 50 bps rate cut. In a nice spin, Chairman Powell said that the Fed’s patience in waiting for conclusive data is what has allowed this move to happen. (“Timing” is all in the eye of the beholder.)
There was a logical question about how sensitive the Fed would be to labor market developments — prompting more aggressive interest rate action— given that the Fed already expects the unemployment rate to rise. This question is really related to an earlier question citing the reality that the labor market often moves rapidly and in unexpected ways. Is the unemployment rate truly likely to move up incrementally and slowly, providing room for the Fed to act propitiously before the unemployment rate ends up at, say, 5.5? This is the big question, especially given that this Federal Reserve has seemed notably at-sea in understanding the US labor market, including labor force participation rates and the signals from competing labor market surveys. The answer was couched in the “data-driven” language so often employed by this Federal Reserve, without addressing the issue of time lags that might mean responding to current data will nevertheless fail to have quick enough action. It is not clear if anyone was fully satisfied with Powell’s answers on this subject.
Chairman Powell offered some discussion about where interest rates are headed in the longer term. Once again, Powell emphasizes that the “neutral rate of interest” (R*) is not well-identified except, perhaps, in hindsight. His “gut feel” continues to be that the neutral rate is quite a bit higher than it was in the recent past.
Chairman Powell made interesting observations regarding housing inflation. Specifically, growth in market rents has slowed, as hoped, but housing inflation is going to take longer than once anticipated to come down. Nevertheless, “housing inflation does not stand in the way of getting to the 2% inflation target.” In part, there is an expectation that as mortgage rates come down, new supply will come into the housing market as people previously ‘frozen” by the need to hold onto their relatively low-interest mortgages will be free to sell. However, the long-term problem of an inadequate supply of housing is very real — and this isn’t a problem the Federal Reserve can solve.
Near the end of the press conference, Powell highlighted an important distinction between “high prices” and “high inflation.” In saying that the Fed has achieved its goal of having inflation be less of a day-to-day decision-making complication for people, he acknowledged that consumers are certainly continuing to deal with high prices, even if they are not worrying about high inflation. Left unsaid, unfortunately, is a tie-back to wage and salary growth, which is now well ahead of measured inflation. Ultimately, that compensation growth is what will provide the support for accommodating the high prices, over time.
Chairman Powell’s parting comments were noteworthy, challenged by a seemingly frustrated Yahoo Finance reporter asking if he isn’t really, truly, honestly worried about the labor market and that this is why the 50bps cut was undertaken. “No” was the resounding answer. [We are] “recalibrating our policy over time to a stance that is more neutral.” “I don’t see anything in the economy right now that suggests that the likelihood of a downturn is elevated.”
There was no single word that dominated this press conference. “Appropriate” came the closest, followed by “recalibrating.” The tone of the press conference was unmistakable, however: confidence, control, “We got it all in hand, and we aren’t worried.” It is rather amazing that no one— not Powell, not the reporters— used the words “soft-landing” even once. Perhaps it was simply too apparent; the FOMC is saying that this is the soft landing, and the knowledge of this imbued Chairman Powell’s remarks. Let’s hope they are right.
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