Federal Reserve’s Next Steps: Insights from Chairman Powell

At a recent press conference, Chairman Powell acknowledged the recent positive developments regarding inflation and stated that the labor market has returned to its pre-pandemic state, likely no longer being a significant source of inflationary pressure. He argued that the Federal Open Market Committee (FOMC) should not overreact to a few good data points. However, he expressed confidence that inflation is on a sustained path back to 2%. As a result, officials are prepared to start adjusting policy to a slightly less restrictive level than today.

Chairman Powell outlined the factors the committee will consider when assessing the feasibility of lowering rates, stating:

“The question will be whether the combination of data, changing outlook, and risk balance aligns with growing confidence in inflation and maintaining a strong labor market. If this test is met, lowering our policy rate could be on the table as soon as the next meeting in September.”

It is important to note that Chairman Powell refrained from signaling any actions beyond September, instead emphasizing that the committee has “made no decisions regarding future meetings.”

The outlook, including the impact of monetary policy and the growing uncertainty around fiscal policy in light of the upcoming U.S. presidential elections, will be crucial factors the Federal Reserve will need to continuously weigh. Due to this uncertainty, Powell stressed that decisions will be made on a meeting-by-meeting basis.

What’s the Bottom Line?

The Federal Reserve has confirmed that it is close to beginning its first rate cut following a period of sharp inflation post-pandemic, which led to one of the fastest and most aggressive rate-hike cycles in decades. Progress in combating inflation has continued and broadened after a pause earlier this year. Additionally, labor markets appear to have balanced after the pandemic-related labor shortages exerted pressure on wage growth.

These developments have contributed to the emergence of dual risks for the Federal Reserve’s dual mandate, not just inflationary risks. This likely means that the Federal Reserve will lower rates several times, starting in September, at a measured pace over the next few quarters and beyond. However, the outlook remains uncertain, and the U.S. presidential elections and their resultant policy shifts add to this uncertainty. Nevertheless, at this moment, the Federal Reserve must position its policy as best as possible amid the uncertainty, which means beginning a gradual adjustment back towards a neutral stance.

Market Reactions

The decline in the dollar, stocks, and yields intensified after a weak employment report heightened concerns that the Federal Reserve might again be behind the curve, meaning it might be slow to cut interest rates. The fall in major tech stocks also fueled the stock market’s tumble.

Contracts on the S&P 500 dropped 1.6%. Nasdaq 100 futures fell 2.3%. Intel Corp. shares plunged 20% in early trading due to a grim growth outlook. The rally in Treasury bonds continued for the seventh consecutive day.

U.S. employment growth in July was below forecast, and the unemployment rate rose to its highest in nearly three years, suggesting the labor market is cooling faster than other data imply. Nonfarm payrolls increased by 114,000 last month following downward revisions to the previous two months’ data, the Bureau of Labor Statistics reported on Friday. The unemployment rate unexpectedly rose for the fourth consecutive month to 4.3%.

The U.S. labor market cooled more than expected in July, adding 114,000 jobs with an increasing unemployment rate, strengthening the argument for the Federal Reserve to cut interest rates at its September meeting.

Data from the Bureau of Labor Statistics released on Friday were significantly below economists’ expectations of 175,000 new jobs, as well as the downwardly revised figure of 179,000 jobs added the previous month.

The unemployment rate rose to 4.3%, marking the fourth consecutive monthly increase.

Treasury yields, the dollar, and stock futures fell following the data release.

Futures traders increased their bets on rate cuts, now expecting four to five cuts this year compared to three or four before the report.

The data came amid accelerating stock sell-offs in Europe and Asia on Friday, driven by growing concerns over a slowdown in U.S. economic growth following disappointing results from consumer and tech companies earlier this week.

Powell stated that he no longer needs to see evidence of labor market weakening to feel confident that inflation is under control.

BT

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