MNI POLICY: Bumpy US Data Won't Take Fed Off Steady Course

MNI (WASHINGTON) - Growing optimism within the Federal Reserve that the U.S. expansion will continue to create jobs without sparking new underlying inflation pressures bolsters the case for a steady series of quarter-point rate cuts over the next several meetings, even as investors second-guess how fast the Fed will ease policy.

Fed officials who left the door open to further 50-basis-point cuts last month are now making a case for gradual easing and downplaying the importance of major upcoming data releases, despite knowing that these will be bumpy. Hurricanes Milton and Helene – the deadliest since Katrina – as well as the Boeing strike will distort labor market reports this month, while CPI in October could see its largest increase since April, partly due to seasonal adjustments, according to a UBS analysis.

The yield on the benchmark 10-year Treasury note has risen almost 60 basis points on a rash of strong economic data since the Fed’s 50-basis-point rate cut on Sept. 18. While the prospect of bigger fiscal deficits after the presidential election or increased geopolitical tensions could sideline arguments for Fed cuts next year, the bar is high for any near-term pause. 

Fed officials who worry about upside risks to inflation from strong aggregate demand still see room to lower rates before policy nears neutral territory. They calculate that the central bank will have the luxury of looking through transitory price shocks from supply chains and geopolitical developments because its successful response in the pandemic strengthened its credibility and anchored inflation expectations. (See MNI INTERVIEW: More Cuts Before Fed Fine-Tunes Neutral -Mester )

SMOOTH LANDING

Earlier concerns about the risk of a hard landing that underpinned the jumbo rate cut in September receded after that month's payrolls report showed an acceleration in job growth and a decline in the unemployment rate. Sizable upward revisions to GDP and the savings rate also showed the recovery from Covid was even stronger than previously thought.

Last week's robust retail sales report provided more good news, prompting analysts to raise consumer spending estimates even higher for the third quarter. Initial unemployment claims fell by more than expected in the week ending Oct. 19, but Labor Department data Thursday also showed the labor market normalizing, with the total number of people collecting benefits now the highest in nearly three years at 1.897 million. 

Fed officials see the economy as largely evolving as desired, but remain wary of any potential shocks that could buffet it away from the desired path. So far, data have offered relief the economy was not sinking into a recession brought on by the Fed's aggressive rate hikes to contain inflation. All that builds a solid foundation for a continued soft landing, even if data veer from a rosy outlook in the near term. 

Fed Governor Chris Waller last week flagged the potential for more than 100,000 jobs to be missing from the October payrolls report due to the hurricanes and the strike, potentially lifting the unemployment rate. Still, the labor market is "on a solid footing," he said. "Whatever happens in the near term, my baseline still calls for reducing the policy rate gradually over the next year."