RPT-MNI POLICY: Fed Prefers Gradual Rates Easing If Jobs Allow

(Story first published Sept. 3)

MNI (WASHINGTON) - Federal Reserve officials are setting course for interest rate reductions of no more than a quarter-point at least at every other meeting starting this month, so long as the labor market doesn't hit major turbulence that requires more aggressive action. 

Having grown confident they are close to defeating the post-Covid surge in inflation, policymakers have shifted their focus to avoiding any more weakness than necessary in the labor market. ​Fed Chair Jerome Powell drew a new line in the sand in Jackson Hole last month, declaring the Fed does “not seek or welcome” any further weakening in the job market. (See MNI POLICY: Fed Increasingly Convinced It Defeated Inflation) 

But despite investors' pricing in a significant chance of a 50-basis point cut this month, only a shockingly bad August jobs report Friday, or additional deterioration of employment conditions down the line, could upend the Fed's cautious approach. 

Another reason officials prefer a gradual series of cuts is a growing suspicion within and outside the FOMC that the neutral rate of interest has risen. That means the central bank might not have to reduce rates by much more than 150bp to get policy back to a more neutral stance.

IN GOOD HEALTH

Wall Street expects U.S. employers to have added 163,000 jobs last month and the unemployment rate to stay steady or retreat a tenth to 4.2% after an unexpected bounce in July stoked fears of recession. 

A slight rise in the jobless rate would not be cause for alarm, as other employment indicators and the real economy look solid. A slowdown in hiring rather than layoffs has led the cooling in the labor market, which officials say is at least as healthy as in 2017. The number of new claims for jobless benefits has trended down in recent weeks, and an influx of immigrants to the workforce could have accounted for some of the rise in unemployment. (See: MNI INTERVIEW: US Job Worries Grow - Conference Board)  

Consumer spending, which comprises two-thirds of U.S. economic activity, accelerated in July after driving GDP growth to a 3.0% annualized pace in the second quarter. Household and firm balance sheets are in decent shape. Banks have held up and lower rates should take some pressure off lenders. 

DATA DEPENDENT

Against this backdrop, most FOMC members still think the economy and the labor market are strong, and therefore don’t see the urgency to cut rates too rapidly. Normalizing monetary policy is expected to take a few years if the economy extends its soft landing. 

If instead the economy surprises to the downside, officials are well positioned to adjust policy more quickly. 

Traders are pricing in 225 bps of cuts through the end of 2025, quite a bit more than the 150 bps or so to get to the top of the range of FOMC views on neutral. Fed officials projected in June they would only reach the middle of that range after 2026.