MNI: Fed Rate Cut Pace Hinges Strongly On Jobs - Ex-Staff

MNI (WASHINGTON) - The speed and extent of Federal Reserve rate cuts expected to start in September will depend on how much the labor market and the economy weaken in the months ahead, former senior Federal Reserve staffers told MNI.

“Inflation has receded substantially as a risk, so leaning into the full employment side of things is much easier,” said Seth Carpenter, who spent 15 years at the Fed’s board of governors, including as Deputy Director of the Division of Monetary Affairs.

For Carpenter and others, when it comes to charting the path of interest rate cuts, the maximum employment side of the Fed’s dual mandate is more of a wildcard. But as things stand, Carpenter thinks the Fed will cut rates by 25 basis points at every meeting from September through June 2025.

“That view was seen as very aggressive not too long ago, but was based on continued clear disinflation," said Carpenter, now global chief economist at Morgan Stanley. "A very weak labor market could change that view and lead to more cuts."

The FOMC’s last statement shifted the central bank’s implicit balance of risks, moving from being “highly attentive” to inflation to being “attentive to the risks to both sides of its dual mandate.”

MARKET JET FUEL

Jan Groen, a former senior New York Fed economist, says that tilt, coupled with a weaker-than-expected July jobs report that was driven by seasonal quirks, helped fuel market speculation of a truly aggressive start to Fed easing. That has since receded with the market now pricing in under 100 basis points of cuts by year-end.

“Fed Chair Powell in his post meeting remarks made it pretty clear that he and other core members of the committee are paying more attention to the labor market cooling and they probably are a little bit more cautious and not wanting to see the cooling morph into a deterioration of the labor market – basically a recession."

The Fed at the moment appears ready to begin cutting interest rates by a smaller quarter percentage point in September, former Fed economists say, particularly after robust retail and jobless claims data reined investors back from betting on an outsized initial 50 basis point reduction in borrowing costs. (MNI: Fed Seen Sticking To 25BP Cut In Sept Post-CPI-Ex-Staff)

Ex-Fed staffers generally do not believe the labor market is pointing to a recession. “It’s a cooling labor market, it’s weakening, but it’s not necessarily off a cliff. The consumer is still solid," said Groen.

INFLATION STILL MATTERS

The Fed’s increased focus on jobs doesn’t mean its attention to inflation has suddenly vanished. A number of Fed members have recently stated they need to see more data before gaining confidence of a sustained inflation decline.

“I think it is fair to say that the labor market is now co-equal with inflation data. If you believe inflation is now contained, then clearly you would argue that labor market data will be more important going forward. But any upside surprise to inflation will take cuts off the table,” said Joseph Gagnon, a former Fed board economist.

That tug-of-war could keep the rate-cut cycle gradual, shallow, or both, said former staffers. In that light, Groen thinks barring a serious worsening of the jobs picture he does not currently expect, market pricing for the Fed to rush its way back to neutral is a bit overdone.

“I don’t know there’s a lot of appetite for that within the Federal Reserve given that you still have relatively strong growth,” said Groen. “Inflation is easing but underlying trends will probably take a while before you really in the long-term, on average, are close to 2%. I think dialing back a little bit of restrictiveness is what most policymakers are aiming for.”