Jay Powell faces milestone decision to cut US rates

Jay Powell laid bets for the US economy three months ago as the Federal Reserve moved toward its first interest rate cut since the pandemic.

“It's a consequential decision,” the Fed chair told reporters when asked about the pace of easing in June, adding: “You want to get it right”.

With fears about jobs giving way to inflation fears, the Fed is set to begin the first of a series of expected interest rate cuts this week, finally giving Americans some relief after more than a year of keeping borrowing costs at 23-years. Maximum 5.25-5.5 percent.

“In all likelihood, this is the start of an easy cycle that's going to go a long way, and by that standard, it's a fairly important meeting,” said Alan Blinder, who served as the Fed's vice-chair. In the early 1990s under Alan Greenspan.

For Powell, the Fed's ability to prevent further weakness in the labor market and stave off a “soft landing” will be critical to burnishing his legacy of navigating the global financial system through the biggest contraction since the Great Depression and the worst inflationary crisis. decade

Historians cite the Fed's actions under Greenspan as the central bank's most successful in reducing inflation without triggering a recession.

“That's when Greenspan became a god, but it was easy compared to what they're dealing with now,” said Blinder of the current Fed leadership, which has had to navigate the pandemic, the war in Ukraine and even worse inflation. overshoot “If Powell achieves [a soft landing]He will go into the Federal Reserve Hall of Fame.”

The Fed's success may depend in large part on how quickly it returns monetary policy to a more “neutral” setting that neither stifles nor encourages growth. Ease too quickly and the central bank risks entering high inflation. Too slowly, and it risks undue economic loss.

On the line are historic gains for workers saved after the Covid-19 shock, as well as the potential impact of the US presidential election in November, with Kamala Harris and Donald Trump neck and neck in the polls.

Striking the right balance is top of mind as officials craft their policy paths. Their first decision will come Wednesday, whether to choose a traditional quarter-point cut or lead with a larger, half-point move.

The futures market is pricing the odds of both outcomes equally.

“There's every reason to think the US economy could make a soft landing with appropriate policy,” said Julia Coronado, a former Fed economist who now runs Macropolicy Perspectives.

Coronado called for starting the rate-cutting cycle with a bumper half-point reduction and lowering the policy rate by a full percentage point over the course of the year. He expects it to drop another 1.5 percentage points by the end of 2025.

Since the Fed's last meeting in July, when several policymakers considered a rate cut “appreciable,” the data has been mixed. Inflation has slowed, but there is some lingering stickiness. After a weak July jobs report, monthly gains picked up in August as the unemployment rate eased. Other measures of demand, such as vacancies, continue to decline.

Against this backdrop, more than 90 percent of economists surveyed in a recent FT-Chicago Booth poll thought the Fed would move slowly with a quarter-point cut on Wednesday, projecting a softer landing.

“Communication is going to be everything here,” said William English, a Yale professor who served as the former director of the Fed's monetary affairs division, adding that in terms of size it will be “as important as the decisions they make.” of steps

“If they do 25 [basis points]They will want to be clear that they are not just hopelessly behind the curve and oblivious to what is happening in the economy, and that they will move quickly if necessary,” he said. “If they do 50 [basis points]They'll want to be clear that they're not really marching too fast to be neutral.”

“It's easy to screw up from both sides,” he warned.

Ellen Mead, who serves as a senior adviser to the Fed's board of governors until 2021, warned that neither option, like most past decisions under Powell, is likely to receive unanimous support.

“Opposition really is your friend, in describing close calls,” he says, adding that it depends on who disagrees as well as the number of opponents. More than two “will attract too much attention”.

Rate decisions will be accompanied by a set of economic projections and an updated “dot plot” combining officials' individual forecasts for the policy rate.

If the Fed leads with a half-point move, economists expect the dot plot to show a full percentage-point decline over the course of the year, suggesting two more quarter-point cuts at each of the remaining meetings.

A quarter-point move could limit estimates to 0.75 percentage points over that same period, or risk questions about why policymakers didn't start with a bigger adjustment.

Looming over the Fed and the world's largest economy more broadly is the US presidential election, just seven weeks after the September rate decision.

“The fall of an American election year is always fraught with danger for the Fed and every agency of the government,” said Patrick McHenry, Republican chair of the House Financial Services Committee.

The Fed wants to stay out of politics, and Powell insisted that the central bank makes its calls based only on “data, vision and the balance of risks.”

But Trump has already warned the Fed not to cut interest rates before the election, a view that some Republicans have abandoned.

If Trump wins a second term, the fear is that he will increase the opposition to the Fed that characterized his first term as a more direct push toward independence, which is codified in law and accountable only to Congress.

But he will face pushback. Gary Richardson, who served as historian of the Federal Reserve System from 2012 to 2016, noted that “there is very little the president can do” when it comes to trying to shake up the Fed and its top brass.

McHenry said he would “always” be a supporter of Fed independence, which has “benefited the US dollar and price stability over the long term”.

“There's a lot of risk there, but I think Jay Powell is in a better position to weather whatever storms come his way because of his past behavior and the relationships he's built with the mountain people,” added Donald. By Donald Cohn, former Fed Vice-Chair.