Powell’s speech on Friday at the Jackson Hole Economic Symposium made clear that the Fed will begin rate cuts at their September meeting. He also made clear that he no longer sees the labor market as overheated, and that the Committee does not want to see the labor market weaken more than it already has. His speech marks the strongest commitment of the Fed to the labor market side of the mandate that we’ve seen since the Fed began raising rates:
"We do not seek or welcome further cooling in labor market conditions… we will do everything we can to support a strong labor market as we make further progress toward price stability."
Jay Powell, Sept. 23, 2024
Almost as notable as the things Powell said were the things he did not. Missing from his speech is either a prescription or prediction that the path of rate cuts will be “methodical”, “gradual”, “prudent”, “slow”, or “careful.” Those are terms that the rest of the Committee has used to describe how they envision the cutting cycle. In just the week before Powell’s speech, we saw several members of the Committee argue for a gradual pace of rate cuts.
Mary Daly downplayed the need for larger cuts and instead argued for “gradualism” given the strength of the labor market, saying “gradualism is not weak, it’s not slow, it’s not behind, it’s just prudent.” The day before Powell’s speech, Harker defended a slower pace of cuts by saying that business leaders in his district wanted a more “methodical” approach to easing after the experience of rapid rate hikes on the way up. Susan Collins also wants to recalibrate policy “in a methodical” way. Even Goolsbee, the Committee member that has been most outspoken about the need to start rate cuts, said he preferred a “gradual” pace of rate cuts.
By not following the rest of the Committee in pre-prescribing the pace of rate cuts, Powell has kept the door open to a faster pace of rate cuts if the data demands it. This includes the possibility of a 50 bps cut at the September meeting, something that we’ve been arguing for as part of a rate normalization strategy that involves front-loading rate cuts to preempt labor market risk. Powell’s strategy of communicating a strong commitment to full employment and keeping the rate path open to a faster pace is a sound one for a number of reasons.
Given the uncertainty around the labor market, there’s no reason to lock in a gradual path of rate cuts. On many dimensions, the labor market still looks very strong. Prime-age employment is at record highs, layoffs are low, and the unemployment rate—despite its recent rise—is less than a percentage point above its historical low. However, there are clear signs of weakness in the labor market, most notably in hiring activity and local trends in the unemployment rate. This particular combination of labor market trends is unprecedented. Given the uncertainty around the labor market trajectory, why pre-prescribe a slow path of rate cuts?
The Fed has been trading timeliness for certainty. For months, the most common phrase out of the mouths of Committee members has been that they need to see "more data" before committing to a cut. Bostic went so far as to say that the Fed needs to “be absolutely sure” that inflation is on its way back down to 2% before cutting. In the face of noisy data that sometimes does not get resolved until well after the fact, waiting for absolute certainty comes at the cost of timeliness. In that case, the Fed needs to cut faster when they do start cutting in order to play catch-up.
If the Fed is uncertain about the neutral rate of interest, larger cuts make more sense in the beginning, not the end. One of the reasons that some FOMC members have cited to avoid starting rate cuts is that they believe the neutral rate of interest (“r-star”) may be higher post-COVID. However, this means that the time to be slow and methodical is at the end of the rate-cutting cycle as the FOMC “feels out” the neutral rate of interest. Right now, the Fed’s policy rule is well above neutral levels implied by conventional monetary policy rules, even if the neutral rate of interest has risen.
Committee members have been arguing that prematurely cutting rates and undoing progress on inflation could lead to another cycle of rate hikes. A similar risk exists in the other direction: going too slowly on rate cuts could lead to the need to cut rates more rapidly in the future if the Fed finds itself behind the curve. Gradualism for the sake of gradualism may just shift the timing of rapid rate cuts to the future.
Powell realizes that the balance of risks between inflation and the labor market means that the Fed shouldn’t lock themselves into a gradual pace of rate cuts. Doing so goes against the principle of “data dependence” that FOMC members have been constantly saying they’re committed to.
The rest of the Committee needs to follow suit. Between now and the next meeting, we’ll receive another month of both labor market and inflation data. The labor market data begins immediately prior to the blackout period, and the inflation data will come out during the blackout period. Between now and then, Fedspeak should focus on keeping the Committee’s options open to a 50 bps cut in September.
