Three months ago, Jay Powell, the chairman of the Federal Reserve, recognised the significant impact the Federal’s first post-pandemic interest rate cut could have on the US economy. Acknowledging the critical nature of the pace of economic relief, he emphasised the importance of calibration in this undertaking.
As concerns around inflation are being replaced by increased worries over employment, the Federal Reserve is preparing to initiate a series of anticipated reductions in interest rates. The aim is to alleviate the strain on Americans who have been grappling with the rising costs of borrowing, which have reached a 23-year high, fluctuating between 5.25% to 5.5%.
Alan Blinder, formerly the vice-chairman of the Federal Reserve during Alan Greenspan’s period as chairman, cited this as an instance of great significance, stating that it potentially represented the onset of a far-reaching cycle of easing.
Jay Powell is up for a considerable challenge as the ability of the Federal Reserve to prevent any further slump in the labour market, while efficiently enabling a ‘soft landing’ for the economy, will crucially shape his reputation as a guide through the worst inflation crisis in several decades and the most substantial global financial contraction since the Great Depression.
Historically, the strategies used under Greenspan’s leadership have been hailed as some of the most effective steps in curbing inflation without triggering a recession. Drawing a comparison between the contemporary situation and the past, Blinder highlighted the complex challenges presently faced by the Federal Reserve due to the pandemic, economic implications of the war in Ukraine, and the escalation of inflation.
A possible entry in the Federal’s equivalent of a hall of fame for Powell rests on the ability of the Reserve to recalibrate its monetary policy, neither suppressing nor boosting growth, to avoid either embedding high inflation or causing undue economic harm.
At stake are the considerable gains made by workers in the wake of Covid-19 and potential influence on the impending US presidential race in November. As Kamala Harris and Donald Trump vie closely in polling, Federal officials are conscious of reaching the optimal equilibrium as they strategise their approach. Their imminent decision, due for Wednesday, will determine whether they will opt for a traditional quarter-point cut or pave the way with a heftier half-point move.
Alan Blinder, who was vice-chairman to Alan Greenspan at the Federal Reserve, suggests that the success of present Chairman Jerome Powell would establish his prominence in the institution’s history. Blinder made this statement in reference to the challenges facing today’s economy compared to Greenspan’s era.
The future markets are currently indicating an equal likelihood of any outcome. Julia Coronado, former Federal Reserve economist and current MacroPolicy Perspectives head, believes that if the right policies are implemented, the US economy can successfully grasp a soft landing. Throughout the year, she advocated for initiating the cycle of rate cuts with a significant half-point reduction, and bringing the policy rate down by one percentage point. She anticipates a further drop by 1.5 percentage points by the end of 2025.
Post the Federal Reserve’s last meeting in July, where a rate cut was deemed a possible option, the data has shown varied results. On one hand, inflation has subsided, but on contrast, a certain degree of persistent inflation can be observed. In spite of a disappointing job report in July, a surge in monthly growth was seen in August with a minor decrease in the unemployment rate. However, other demand indicators, such as vacancies, have consistently been on the decline.
In the light of these circumstances, more than 90% economists surveyed in the most recent FT-Chicago Booth poll believe that Federal Reserve would proceed cautiously with a quarter-point reduction, aiming for a soft landing.
The significance of communication in the current scenario was underlined by William English, Yale Professor and former director of Federal Reserve’s division of monetary affairs. He acknowledged that the clarity of the Fed’s intentions, regardless of whether they choose a 25 or 50 basis point move, would be as crucial as the decision itself.
However, a word of caution was provided by Ellen Meade, former senior advisor to the Federal Reserve’s board of governors. She warned that unlike Powell’s most past decisions, there likely won’t be a unanimous agreement on either of the options.
“Dissents can be advantageous in tight call situations,” she noted, stating that the number of dissents and who exactly dissented are relevant factors. She emphasised, however, that an opposition of more than two “would draw significant attention”.
Alongside the interest rate decision, there will be an accompanying set of economical forecasts and an updated, individualised “dot plot” forecast from officials for the policy rate.
Economists predict that if the Federal Reserve (Fed) kickstarts with a half-point move, the dot plot would depict a full percentage-point drop over the year, which suggests two additional quarter-point reductions at each remaining meeting.
On the other hand, a quarter-point move might limit projections to 0.75 percentage points over the same time period or else risk provoking inquiries as to why the policy makers didn’t opt for a larger adjustment from the outset.
Leading the world’s biggest economy, the Fed is cognisant of the looming US presidential election, only seven weeks post the September interest rate announcement.
Patrick McHenry, the Republican chairman of the House of Representative’s financial services committee, explained that the autumn of a US election year is always filled with obstacles for governmental agencies, including the Fed.
The Fed aims to maintain political neutrality, with Powell emphasizing their decisions are based completely on “the data, the outlook, and the balance of risks”.
Already, President Donald Trump has cautioned the Fed not to cut interest rates before the election, a viewpoint some Republicans have dismissed. If Trump secures a second term, there’s a worry that he might step-up his hostile approach to the Fed from his initial term and try to undermine their independence, which is protected by legislation and makes it accountable solely to Congress.
Opposition would exist, nevertheless. As noted by Gary Richardson, historian of the Federal Reserve System from 2012-2016, “very little the president can do” to overhaul the Fed and its leaders.
McHenry maintains he will “continuously” support the Fed’s independence, contributing over time to the stability of the US dollar and prices.
“While many risks out there exist, Jay Powell is exceptionally positioned from his past conduct and relationships he’s created with people on the Hill, to withstand any storm that might come his way,” concluded Donald Kohn, a previous Fed vice-chairman. – Copyright The Financial Times Limited 2024