US Federal Reserve Chair Jerome Powell testified before the Senate Banking, Housing, and Urban Affairs Hearings to examine the Semiannual Monetary Policy Report to Congress on July 9, 2024. As Federal Reserve officials gear up for their policy meeting, they are closer to achieving their goal of low inflation. However, the extent to which they will adjust interest rates remains uncertain.
Inflation data from the past week revealed a significant decrease in price pressures since their peak in 2021-22. One indicator of consumer prices showed that 12-month inflation was at its lowest since February 2021, while wholesale price measures indicated that pipeline price increases are mostly under control. These readings have paved the way for a potential interest rate cut at the upcoming Federal Open Market Committee meeting.
Economists and analysts are now debating how aggressively the Fed should act in response to the recent inflation data. Market expectations have fluctuated, with futures markets initially predicting a quarter percentage point rate cut, but later shifting to an almost even chance of either a 25- or 50-basis point reduction. Claudia Sahm, chief economist for New Century Advisors, believes that the Fed should opt for a larger rate cut to support the labor market and maintain economic stability.
“The labor market [since] last July has gotten weaker,” Sahm noted. “So there’s an aspect of just recalibrating. We got some more information. [Fed officials] need to kind of clean it up, do a 50 basis point cut and then be ready to do more.”
The latest inflation reports suggest that while the battle to bring inflation back down to 2% is ongoing, progress is being made in the right direction. The consumer price index in August rose by just 0.2%, resulting in a full-year inflation rate of 2.5%. Core inflation, excluding food and energy, stood at 3.2%, still above the Fed’s target. Shelter costs have been a significant driver of core inflation, particularly with the owners equivalent rent measure rising by 5.4% from a year ago.
Despite these persistent pressures, consumer surveys indicate confidence that inflation has been contained, if not completely halted. Respondents to a University of Michigan survey in September expected inflation to run at 2.7% over the next 12 months, the lowest reading since December 2020. Fed Chair Jerome Powell expressed confidence that inflation is on track to return to 2%, although challenges remain in terms of employment.
Powell emphasized the importance of maintaining a healthy job market, stating that the Fed does not seek further deterioration in labor market conditions. As the Fed prepares to make its decision on interest rates, the focus is shifting towards striking a balance between stabilizing prices and supporting job growth.
With differing opinions on the appropriate course of action, some economists advocate for a conservative approach with a quarter-point rate cut at the upcoming meeting. Tom Simons, U.S. economist at Jefferies, highlighted the need for the Fed to normalize policy without overreacting to economic indicators.
“That’s really the key that they need to kind of hone in on, which is that they are normalizing policy and not trying to provide accommodation for an economy that is really in trouble,” Simons explained. “I think they’ve done a very good job of expressing that point of view so far.”
Even with a modest rate cut, there is room for the Fed to make further adjustments in the future. Market expectations suggest that rates could potentially decrease by 1.25 percentage points by the end of 2024, indicating a sense of urgency in lowering borrowing costs from their current levels, the highest in over 23 years.
As the Fed navigates the uncertainty surrounding inflation and the labor market, the upcoming policy meeting will be crucial in determining the course of monetary policy in the near term. The decision on interest rates will have far-reaching implications for the economy and financial markets, with stakeholders closely monitoring the Fed’s actions and statements for insights into future developments.
