WASHINGTON — After two years of tackling inflation aggressively and keeping its benchmark interest rate at a near 25-year high for the past year, the Federal Reserve is anticipated to signal this week a likely reduction in borrowing costs as soon as September. This potential rate cut, the first since the pandemic, represents a significant shift that could positively impact the economy. Typically, Fed rate cuts reduce borrowing costs for mortgages, auto loans, and credit cards over time. With the key rate currently around 5.3%, a single cut might not drastically change the economic landscape but is widely expected by financial markets. Some borrowing costs have already dipped in anticipation. This raises the pivotal question for the central bank: How quickly and substantially will the policymakers lower the rates?
Economic and Political Implications
This question holds considerable interest for the major presidential candidates. Rapid rate cuts could stimulate economic growth, potentially aiding Vice President Kamala Harris’ election prospects. In contrast, former President Donald Trump argues for postponing rate cuts until the Fed’s meeting in November, just two days post-election. Futures markets predict a 64% probability that the Fed will cut rates three times this year — in September, November, and December, according to CME FedWatch. This sentiment contrasts with last month’s Fed officials’ forecast of just one rate reduction in 2024 and four in subsequent years, suggesting a more gradual approach with quarterly rate cuts.
Factors Influencing Fed’s Decision
The Fed’s timing will likely hinge on the economy’s performance over the coming months. If growth remains steady and employment strong, the Fed may opt for a gradual rate cut approach. However, a slowdown in the labor market might prompt quicker action. Gennadiy Goldberg, head of US rates strategy at TD Securities, notes that the Fed aims to be cautious but may accelerate rate cuts if hiring slows down.
Labor Market Trends
The labor market is already showing signs of cooling, aligning with the Fed’s intentions. Over the past three months, job growth has averaged 177,000 per month, a drop from the previous year’s 275,000 monthly average. This cooling trend could indicate a more sustainable, less inflationary growth period post-pandemic or could precede a recession. Federal Reserve Chair Jerome Powell and other officials are paying close attention to employment trends as well as inflation. This focus on preventing significant job market weakening has lifted market expectations for a rate cut.
Inflation and Growth Observations
Powell recently noted that elevated inflation is not the sole risk, emphasizing the significance of a stable job market. Despite a slight increase in the unemployment rate, the job market and economic growth appear robust, with a 2.8% annual growth rate in the April-June quarter. William English, an economist at the Yale School of Management, believes the economy remains solid, with no immediate signs of downturn. Powell is expected to provide clearer guidance on future rate moves during his upcoming speech at the annual monetary policy conference in Jackson Hole, Wyoming. Meanwhile, changes in the Fed’s language post-meeting statements may hint at impending rate cuts.
Future Rate Cuts and Inflation Targets
The Fed’s June statement indicated “modest further progress” towards a 2% inflation goal. This week’s statement could alter phrasing to reflect more significant progress. With inflation already below the Fed’s year-end target of 2.8%, further rate cuts could become justifiable. Nevertheless, even as inflation cools, it might stabilize or slightly increase by late 2024 due to last year’s low monthly inflation readings. Fed officials are expected to prioritize three-month and six-month annualized inflation averages. Excluding volatile food and energy categories, the three-month average inflation rate was 2.3% in June, further supporting potential rate reductions.
