The Federal Reserve gave an important clue Wednesday that it will likely cut its benchmark lending rate in the coming months.
The move would pave the way for lower borrowing costs for Americans on everything from mortgages and car loans to credit cards. While the central bank said it will continue to hold rates at current levels, Fed officials are now wary of any risks surrounding America’s labor market, which has long been a pillar of strength for the economy, according to their latest policy statement.
Fed Chair Jerome Powell talked up inflation’s recent progress in his post-meeting news conference, saying “the second quarter’s inflation readings have added to our confidence, and more good data would further strengthen that confidence.” He also conveyed that since the job market seems to be back to a pre-pandemic normal, any additional cooling could be concerning for the Fed.
The Fed’s latest policy statement also suggested that officials view inflation as less of an issue now than at their June meeting. This shift in how the Fed is viewing the economy means the central bank could begin paring back interest rates as soon as its next policy meeting, in September, easing pressure on US households and businesses burdened by tough borrowing costs.
Powell doubled down on his point that determining when to cut rates will be “a very difficult judgement call.” There are consequences both if the Fed cuts too soon, and if it cuts too late.
Chicago Fed President Austan Goolsbee recently cautioned of the effects of inflation-adjusted interest rates, which tighten their grip on the economy if inflation slows but rates remain unchanged. That could be a problem for the labor market, which seems to be at an inflection point. In addition to stabilizing prices, the Fed is also responsible for maximizing employment.
Here are key takeaways from the Fed’s latest meeting, news conference and policy statement.
Powell cheers inflation’s slowdown and the economy’s resilience
It’s crucial for the Fed’s top policymaker to sound confident about inflation before the central bank can begin cutting interest rates, and confident he sounded.
Powell said “inflation has eased notably over the past few years, but remains somewhat elevated from our longer run goal of 2%.” The Fed’s statement also described inflation as “somewhat” elevated, which wasn’t a word that had been used before to describe inflation since the Fed began to lift rates in early 2022. The Fed’s favorite inflation measure, the Personal Consumption Expenditures index, showed that consumer prices were up 2.5% in June from a year earlier, down from May’s 2.6% annual rate, inching closer to the Fed’s 2% target.
The Fed is still very much wary about inflation, but a bit less so now. Powell even said that “we don’t need to be 100% focused on inflation.” Indeed, the second quarter really gave Fed officials a huge relief.
That wasn’t just because inflation resumed a downward trend, but also because economic growth remained solid. The government’s latest report on gross domestic product showed that the US economy expanded at a robust 2.8% annualized rate from April through June, after adjusting for seasonal swings and inflation, which was double the rate seen in the first quarter and well above economists’ predictions. Powell called that a “historically unusual” development.
“This is such a welcome outcome for the people we serve,” Powell said. “What we’re thinking about all the time is, how do we keep this going? And this is part of that.”
All eyes on America’s job market
The future of the job market is now top of mind for the Fed.
Employers aren’t hiring at the same pace they have in recent years, it’s become a lot tougher for unemployed Americans to find a new job, demand for labor has tumbled dramatically over the past two years, wage growth is running at a cooler pace and the unemployment rate is now at its highest point in more than two years, at 4.1%. The Fed is responsible for keeping the labor market intact.
Powell described that slower momentum as an “ongoing gradual normalization,” considering the job market was once running red-hot after it rebounded mightily from the pandemic-induced recession in 2020. But he noted that any significant weakening would be concerning since the job market is “back to where it was on the eve of the pandemic,” he said.
“I wouldn’t say we don’t want to see any other cooling; it would have to be a material difference: If we see something that looks like a more significant downturn, that would be something that we would have the intention of responding to,” he said. “I think we’re in a good place here.”
The Labor Department releases July data gauging the state of the US job market, including monthly payroll growth and the unemployment rate, on Friday.
A highly unusual economic cycle
It’s not clear if the duo of slower inflation and stronger growth will persist. The Fed tries to wrangle inflation by deliberately cooling the economy through higher interest rates, so the latest GDP report went against that conventional wisdom.
Powell said it’s highly unclear how the economy will unfold, adding that effects from the Covid-19 pandemic have undermined conventional wisdom, but he said “history doesn’t repeat itself, it rhymes.”
Plus, it’s already been a year that interest rates have been perched at a 23-year high, and there have been some signs of weakness in the broader economy. For starters, the US consumer is no longer splurging, and shoppers have instead become much more careful with their dollars, according to major retailers such as Target and Walmart. Americans are still very much spending, but they’re now hunting for bargains and prioritizing in-person experiences.
In theory, American shoppers should be tapping out soon, which could spell trouble for the job market. However, last year, the economy’s sheer resilience shocked economists who widely expected a recession, which never happened.
