In Order to Avoid Falling Behind, 50bps in September Should be on the Table
Despite Powell agreeing with all the reasons to do so, the Fed did not cut in July. By delaying rate cuts in search of certainty, the Fed risks being behind the ball. By the September meeting, the data may have revealed that holding in July was a mistake; to catch-up, the FOMC should actively keep the option of a 50 basis point cut on the table between now and the September meeting.
The July FOMC press conference played out as we expected: while the Fed did not cut in July, Chair Powell laid the groundwork for a cut in September. This put him in a difficult position of simultaneously trying to justify a July while indicating that there was sufficient evidence to all but pencil in a September cut at the press conference.
This led to a series of awkward answers to questions by the press corp. A journalist would put forth reasons why a cut now might be appropriate, and ask why, in light of those reasons, the Committee didn’t cut at the July meeting. Powell basically agreed with all of the reasons for a July cut—but not the cut itself.
He agrees that the risks to the labor market have risen:
Timiraos: “If the labor market is back in equilibrium, why is restrictive policy and potentially very restrictive policy, given the high real funds rate, warranted right now?”
Powell: “So this is the very reason that we're thinking... that we're going back to looking at both mandates and that we think the risks are coming back into balance.”
He acknowledges the huge progress made in getting core PCE inflation down, especially in the 12-month measure:
Siegel: “And if we're to think about the first couple months of the year, is there any sense now that they were these blips that could have actually allowed for earlier rate cuts as were some of the projections going into 2024?”
Powell: “...that's why we look at 12 months, we look at 12 months because that takes all that out, all those effects out, 12-month now is two-and-a-half percent headline, 2.6 percent core. This is so much better than where we were even a year ago. It's a lot better. The job is not done, I want to stress that...”
And he recognizes that monetary policy lags might prove a challenge in trying to pivot in time:
Brown: “...when the Fed was raising rates, there was a lot of conversation about long and variable lags. I wonder if that applies on the way down too. How are you and the Committee thinking about that?”
Powell. “Yes, it does. it should take some time to get into the full economy, ... it's not instantaneous.”
Brown: “So are you worried then that if monetary policy acts with long and variable lags, even when you're lowering interest rates, it might be too late for the Fed to help stave off any kind of slowdown in the labor market or broader economy?”
Powell: “We have to worry about that.”
In short, Powell already agrees with all the reasons why the Fed should have cut in July. The only reason that’s really been offered for waiting is the now-tired desire for greater confidence in disinflation.
Schneider: “…specifically in what ways right now, given all you've seen over the last few months, in particular on shelter, on services, etc., in what ways are you not confident right now that inflation is on the way back to 2 percent?”
Powell: “I think it's just a question of seeing more good data… we just want to see more and gain confidence, and as I said, we did gain confidence and more good data would cause us to gain more confidence.”
It’s true that conducting monetary policy is fundamentally difficult in the face of noisy data that is plagued with residual seasonality, declining response rates, and policy lags. The Fed faces a trade-off between responding to the shifts in risk and having certainty. So far, they have opted for certainty—which may put them behind the ball in September. Data-wise, the distance between the July and September FOMC meetings is slightly larger than usual, as we will see another two months of both jobs and inflation reports. Based on Powell’s remarks on Wednesday, that additional data will likely be sufficient to finally provide the Committee with enough confidence to cut. The flip side of that trade-off is that it may turn out that they made a policy error in waiting too long to begin cutting.
In our playbook for Fed Policy in 2024, we advocated for front-loaded cuts to bring down labor market risk early. We can now add an additional justification for front-loaded cuts: the Fed’s decision to wait for more certainty has come at the cost of timeliness; if they fall behind, cuts should be more rapid at the beginning in order to catch up.
Powell laid out some broad criteria for cutting in September, and the bar for a cut isn't that high:
“...if we were to see, for example, inflation moving down quickly, or more or less in line with expectations, growth remains let's say reasonably strong and the labor market remains consistent with its current condition, then I would think that a rate cut could be on the table at the September meeting.”
If we continue to see inflation falling unexpectedly quickly or the labor market deteriorate from here (such as a further decline in the prime-age 25-54 employment rate), the Fed should not only cut in September, they should cut by 50 basis points. They should also be open to cutting at consecutive meetings as part of a front-loaded approach to getting away from unambiguously restrictive policy. Since the FOMC will receive key inflation data during the blackout week just before the September meeting, Fedspeak between now and then should actively keep the door open to a 50 bps cut until then.