Jay Powell laid out the stakes for the US economy three months ago as the Federal Reserve advanced towards its first interest rate cut since the pandemic.
“It’s a consequential decision,” the Fed chairman told reporters when asked about the pace of easing in June, adding: “you want to get it right”.
With fears about inflation giving way to fears about jobs, the Fed is poised to embark on the first in a series of expected interest rate reductions this week, finally offering Americans some relief after more than a year of keeping borrowing costs at a 23-year high of 5.25-5.5 per cent.
“In all likelihood, this is the beginning of an easing cycle that is going to go a long way and, by that criteria, this is a fairly momentous meeting,” said Alan Blinder, who served as vice-chairman of the Fed in the early 1990s under Alan Greenspan.
For Powell, the Fed’s capacity to stave off further weakness in the labour market and pull off a “soft landing” will be pivotal to burnishing his legacy of navigating the global financial system through the largest contraction since the Great Depression and the worst inflation crisis in decades.
Historians have cited the Fed’s actions under Greenspan as among the central bank’s most successful to bring inflation down without causing a recession.
“That is when Greenspan became a god, but it was easy compared to what they are dealing with now,” said Blinder of the current Fed leadership, which has had to steer through a pandemic, the war in Ukraine and a much-worse inflation overshoot. “If Powell achieves [a soft landing], he will go down in the Federal Reserve hall of fame.”
The Fed’s success could hinge in large part on how quickly it returns monetary policy to a more “neutral” setting that neither represses nor spurs growth. Ease too fast and the central bank risks elevated inflation becoming entrenched. Too slowly, and it risks inflicting undue economic damage.
On the line are also historic gains for workers accrued in the aftermath of the Covid-19 shock, as well as a possible impact on the US presidential election in November, with Kamala Harris and Donald Trump neck and neck in the polls.
Striking the right balance is top of mind as officials plot out their policy path. Their first decision will come on Wednesday, on whether to opt for a traditional quarter-point cut or lead with a larger, half-point move.
“That is when Greenspan became a god, but it was easy compared to what they are dealing with now... If Powell achieves [a soft landing], he will go down in the Federal Reserve hall of fame.”
— Alan Blinder, Fed vice-chairman under Alan Greenspan
Futures markets are evenly pricing the odds of either outcome.
“There is every reason to think that the US economy can stick a soft landing with appropriate policy,” says Julia Coronado, a former Fed economist who now runs MacroPolicy Perspectives.
Coronado called for starting the rate-cutting cycle with a bumper half-point reduction and lowering the policy rate by a full percentage point over the course of the year. She expects it to drop another 1.5 percentage points by the end of 2025.
Since the Fed’s last meeting in July, when several policymakers deemed a rate cut “plausible”, data has been mixed. Inflation has retreated, but there is some lingering stickiness. After a weak July jobs report, monthly growth stepped up in August as the unemployment rate ticked lower. Other measures of demand, such as vacancies, have continued to fall.
Against this backdrop, over 90 per cent of economists surveyed in the latest FT-Chicago Booth poll thought the Fed would move gradually with a quarter-point reduction on Wednesday, projecting a soft landing.
“Communication is going to be everything here,” says William English, a Yale professor who served as the former director of the Fed’s division of monetary affairs, saying it would be “as important as the decision that they make” in terms of the size of the move.
“If they do 25 [basis points], they will want to be clear that they’re not just hopelessly behind the curve and oblivious to what’s going on in the economy, and that they’ll move quickly if they need to,” he said. “If they do 50 [basis points], they’ll want to be clear that they’re not on a really fast march to neutral.”
“It’s easy to screw up in both directions,” he warned.
Ellen Meade, who served as a senior adviser to the Fed’s board of governors until 2021, cautioned that neither option was likely to have unanimous support, as most of the past decisions under Powell have.
“Dissents are really your friend in the close-call narrative,” she said, adding that it depended on who dissented as well as the number in opposition. More than two “would draw a lot of attention”.
The rate decision will also be accompanied by a set of economic projections and an updated “dot plot” aggregating officials’ individual forecasts for the policy rate.
If the Fed leads off with a half-point move, economists expect the dot plot to show a full percentage-point reduction over the course of the year, suggesting two more quarter point cuts at each of the remaining meetings.
A quarter-point move may cap the projections at 0.75 percentage points over that same time period, or risk prompting questions of why policymakers did not start out with a bigger adjustment.
Looming over the Fed and the world’s largest economy more broadly is the US presidential election, just seven weeks after September’s rate decision.
“Fall of an American election year is always fraught with peril for the Fed and for every agency of government,” said Patrick McHenry, the Republican chairman of the House of Representatives financial services committee.
The Fed seeks to steer clear of politics and, as Powell has emphasised, that the central bank makes its calls based solely on “the data, the outlook, and the balance of risks”.
Donald Trump has already warned the Fed not to lower interest rates before the election, a view that some Republicans have renounced.
If Trump wins a second term, the fear is that he will escalate the antagonistic approach to the Fed that characterised his first term to more directly gnaw at its independence, which is codified in law and makes it accountable only to Congress.
He will face pushback, however. Gary Richardson, who served as the historian of the Federal Reserve System from 2012 to 2016, noted that there was “very little the president can do” in terms of trying to shake up the Fed and its top brass.
McHenry said he would “always” be a supporter of the Fed’s independence, which has “benefited the US dollar and price stability over the long run”.
“There are lots of risks out there, but I think Jay Powell is as well positioned as anyone could be from his past behaviour and from the relationships he’s built with people on the Hill to weather whatever storm might be coming his way,” added Donald Kohn, a former Fed vice-chairman. – Copyright The Financial Times Limited 2024
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