"The Fed's Signal Transmitter": The Fed clears the way for a rate cut in September

Nick Timiraos, a well-known journalist from The Wall Street Journal, known as the "Fed Whisperer," commented on the latest Federal Reserve decision, stating that officials maintained interest rates but made important adjustments, emphasizing the need to more equally focus on employment and inflation targets. Here is more content from the article:

Federal Reserve Chairman Powell stated that Fed officials may cut interest rates at the September meeting, moving closer to a new phase where, in the face of signs of declining inflation rates, they aim to avoid weakness in the labor market.

While Powell and his colleagues did not commit to any such measures when they kept rates unchanged on Wednesday, he seemed to suggest at the post-meeting press conference that the possibility of a rate cut is greater than no cut.

Powell said, "The overall feeling of the committee is that the economy is approaching the point where it is appropriate to lower the policy rate. It may be appropriate to lower the policy rate as soon as the next meeting in September."

During the 50-minute press conference, Powell mentioned positive news on inflation, the desire to prevent a significant rise in the unemployment rate, and his view that Fed policy is beginning to meaningfully slow economic activity. His remarks did little to dispel the widespread market expectation of a rate cut at the next meeting.

While FOMC officials unanimously decided to keep rates between 5.25% and 5.5%, the highest level in twenty years, Powell hinted that at least one official advocated for a rate cut at the two-day meeting this week.

Jamie Patton, Co-Head of Global Rates at asset management firm TCW based in Los Angeles, said, "This is important because if they were seriously discussing a rate cut in July, then a rate cut in September seems like a done deal, unless something crazy happens between now and then."

Investors currently expect the Fed to continue cutting rates after the initial cut, at the remaining meetings in November and December this year. Michael de Pass, Global Rates Trading Head at Citadel Securities, said, "Labor market weakness is accelerating the rate cut cycle, while inflation stickiness is slowing it down."

Officials made two important modifications to the policy statement, acknowledging recent progress in combating inflation and showing a greater inclination to lower rates without making any explicit commitments.

They noted that inflation is still "a bit high," which is a clear downgrade. They emphasized that this progress means that for the first time since rapidly raising rates two years ago to combat high prices, they can now treat the two aspects of their dual mandate—maintaining low and stable inflation and a robust labor market—on a more equal basis.

The statement said, "The Committee is monitoring the two aspects of its dual mandate," abandoning the wording from the past two years that decision-makers were "closely monitoring" inflation risks.

For Fed officials, the risks are high as they have been trying to avoid two risks. One is prematurely easing policy, leading to inflation persisting at levels above the 2% target. The other scenario is waiting too long, causing the economy to collapse under the pressure of higher rates So far this year, the U.S. economy has shown strong performance. Gross Domestic Product (GDP) is the most widely used indicator to measure the output of the U.S. economy, with a year-on-year growth rate of 2.1% in the first half of this year. Although the inflation rate in the first quarter was unexpectedly high, recent data shows that the trend of slowing price growth in the second half of last year has resumed and may expand.

Powell said, "The situation we see now is better than last year. Last year, price growth slowed rapidly, but the decline was concentrated in goods rather than services. But now it's a more widespread anti-inflation."

Furthermore, recent financial reports show that as consumers tighten their belts to resist the sharp price increases of the past three years, U.S. companies' pricing power is declining.

McDonald's reported a significant drop in sales from April to June, down nearly 1% from the same period last year, issuing a warning to the food industry. McDonald's CEO Chris Kempczinski said in a Monday earnings conference call, "Consumers in many markets are very picky."

In 2022, as inflation soared to a new high in forty years, Federal Reserve officials raised interest rates at the fastest pace in forty years. They are concerned that rapid price increases could lead to entrenched high inflation throughout the economy, especially if prices and wages rise in sync.

However, recent data indicates that this scenario has not occurred. In June, there were 1.2 job openings per unemployed worker, lower than the peak of 2 when the Fed began raising rates in March 2022, returning to pre-pandemic levels. Powell said on Wednesday that he no longer sees the labor market as a source of inflation risk. He said, "I don't want to see a substantial further cooling in the labor market."

While the layoff rate remains low, the hiring rate is also declining. Workers are taking longer to find jobs, with the unemployment rate rising from 3.7% at the beginning of the year to 4.1% in June. When asked if officials are concerned that this may indicate further softening in the labor market in the future, Powell said, "We are watching this very carefully."

After a recruitment boom reignited following the end of the pandemic, wage growth is cooling off. The U.S. Department of Labor said on Wednesday that private sector wages and salaries grew by 0.8% in the second quarter, the weakest growth since 2020.

Some industries most sensitive to high interest rates are facing greater pressure. After a surge in borrowing costs, the number of housing units under construction across the U.S. stabilized in 2022, but residential construction turned negative earlier this year, with a nearly 8% year-on-year decline in June, the largest drop since the real estate downturn of 2006-2011.

The Mortgage Bankers Association said on Wednesday that mortgage rates have dropped to below 7% in recent weeks, but this has not stimulated demand for new mortgages.

The economy has shown greater resilience to rising interest rates than most economists expected, in part because many households and businesses locked in low borrowing costs during the pandemic. However, TCW's Patton stated that if the Fed needs to stimulate the economy, these buffering factors that weakened the transmission of interest rates during the rate hike process may also work against the Fed during a rate cut She said, "That's why we think the Fed is a bit too confident, thinking that as long as they see weakness, they can relax interest rates and everything will be fine. When the data the Fed is focusing on shows weakness, it's already too late."

Democrats are seeking to retain control of the White House in the November election and are frustrated by the cost of higher rates on big-ticket items like homes and cars, which weakens consumer confidence. They are concerned that waiting for the Fed to act will undermine the strong labor market that has been in place.

Others, however, say they are not worried about a serious economic downturn. Frank Sorrentino, CEO of ConnectOne Bank in Englewood Cliffs, New Jersey, said, "I haven't seen many signs of weakness." He said that while the growth rate in industries like fast food has slowed down, many service-related industries are coming down from high levels, but the growth rate is not slow.

When the Fed cuts rates is not so important for his clients, as medium to long-term rates have fallen from last year's highs. Sorrentino said, "Yes, people would feel better if rates go down, but whether it's 25, 50, or 100 basis points, I don't think it will have a significant impact on business operations. The vast majority of our clients have already adapted to this rate environment."