Fed "Megaphone": Rate cut in September will put the Fed in a tough election battle

Nick Timiraos, a well-known journalist from The Wall Street Journal, known as the "mouthpiece of the Federal Reserve," once again wrote after the latest Fed decision that the Fed's rate cut in September opens the door to convenience, which coincides with the heated U.S. presidential election at that time.

For a central bank that wisely wishes to stay away from partisan political disputes, facing potential policy changes before and after the election is nothing short of a lose-lose situation. Cutting rates before the election may anger Republicans and former President Trump, but delaying necessary rate cuts may harm the economy and displease Democrats.

This awkward situation has prompted Fed officials to set expectations for a series of rate cuts that the Fed may initiate at its next meeting in mid-September and explain the reasons behind them in the coming weeks.

Fed Chairman Powell said on Wednesday that his focus is on ensuring that the Fed can lower inflation rates while preventing past rate hikes from pushing the economy into a recession, and he will continue to work long-term to lay such a foundation. Powell said, "Our work is entirely focused on this."

He vehemently refuted accusations that the Fed is influenced by politics. Powell said, "We never use our tools to support or oppose a political party, politician, or any political outcome. Everything we do before, during, or after an election will be based on data, outlook, and risk balance, not on anything else."

Two years ago, the Fed raised rates from near-zero levels and quickly launched the fastest rate hike cycle since the early 1980s to combat inflation. The last time Fed officials raised the benchmark short-term interest rate to around 5.3% was in July 2023, setting a new high for rates in twenty years. During the rate hikes, inflation rates significantly decreased, with inflation falling from 7.1% two years ago to 2.5% in June according to the Fed's preferred measure. The Fed's long-term target is for inflation to reach 2%.

As the Fed's actions can change economic outcomes, they will also indirectly have significant political consequences. Economic models show that because bond investors have already anticipated at least two, if not three, rate cuts this year, the specific timing of rate cuts should not have a direct impact on the labor market, economic growth, and inflation.

But before the Fed cuts rates, consumers with credit card debt and businesses relying on short-term debt will not benefit. In addition, this policy shift carries important symbolic significance and may boost consumer sentiment. Furthermore, the market currently widely expects the Fed to cut rates in September, and if the Fed does not follow suit, borrowing costs may rise, and other financial conditions may tighten.

Republicans Increase Pressure

In June this year, Trump told Bloomberg Businessweek that the Fed's current rate setting is "very difficult for the economy," but lowering rates before the election is something officials "know they shouldn't do."

Trump's allies have signaled that if Powell continues to cut rates in September, they will politically pressure him. They are concerned that rate cuts will boost sentiment and provide Democrats with a victory topic on the economy During the Trump administration, Michael Faulkender, an economist at the Treasury Department, said, "If they wait until after the November election to cut interest rates, the impact will be minimal."

The next meeting of the Federal Reserve will be held on September 17th and 18th, with the following meeting starting on the day after the November 5th election.

Faulkender, the current Chief Economist of the pro-Trump think tank "America First Policy Institute," believes that initiating a rate cut before the election would appear very politicized.

Some Republicans have expressed that even though Trump heavily criticized the Fed's rate cut in September, if he is re-elected, any hawkish sentiment will dissipate as he would want a strong economy.

Former economic advisor to President George W. Bush, Marc Sumerlin, said, "There is a good argument that if Trump wins, he will quickly forgive the Fed... In fact, he would be pleased with the Fed's promised rate cut as he is about to take office."

Bitter Medicine

Three years ago, many Democrats in Congress who were trying to pass ambitious government spending plans on Capitol Hill predicted that the high housing prices, which initially posed a fatal threat to the legislative agenda, would fade away on their own.

Now, some are concerned that Vice President Harris's campaign will not benefit from the recent slowdown in inflation, as the Fed's rate prescription is as unpalatable as the price pressures it is trying to control. Higher rates make the cost of purchasing big-ticket items like cars and homes higher, and these items are often purchased with debt.

Kitty Richards, who is overseeing economic stimulus spending at the Treasury from 2021 to 2022, said, "Given the wage growth American workers have seen during the economic recovery, this has indeed made some projects that were once affordable now out of reach."

Former Biden administration officials and some former Fed officials have argued in recent weeks that the Fed should cut rates now to prevent any unnecessary softening in the economy and maximize the chances of achieving a soft landing that is difficult to achieve.

Former White House economic aide Bharat Ramamurti said, "Fiscal and monetary policy have together created an exceptionally strong recovery. The finish line is in sight, and if the Fed stumbles and falls in the marathon race with 0.1 mile to go, it would be tragic..."

On Wednesday, three Democratic senators, including Elizabeth Warren of Massachusetts, wrote a letter urging Powell to lower rates, stating that due to the high rates, not lowering them would be equivalent to "yielding" to Republican "political threats".

Policy changes near elections are not uncommon

Federal Reserve officials have stated that incorporating the election schedule into consideration would go against their non-political practices. Powell stated on Wednesday, "We believe that Congress has instructed us to conduct our business in a non-political manner at all times, not just at certain times "

Eric Rosengren, who served as the President of the Boston Federal Reserve from 2007 to 2021, stated that due to inflation falling slightly faster than officials' expectations at the June meeting, and the unemployment rate gradually rising, the Federal Reserve has sufficient reason to cut interest rates as soon as possible.

He said, "The non-political approach is that if you think policies will be too tight after the end of the year, you should loosen them. Avoiding taking what you think is the appropriate policy is a political act."

History has shown that it is not uncommon for the Federal Reserve to change policies around elections:

• In July 1992, the Federal Reserve cut interest rates by 50 basis points, and then by 25 basis points in September of the same year, as the economy was struggling to recover from a recession. The rate cut in July came a few days after President George H.W. Bush, seeking re-election, called for a rate cut. (Bush ultimately lost, and years later, he criticized then-Fed Chairman Greenspan for keeping rates too high).
• In May 2000, the Federal Reserve raised interest rates to the highest level in nine years, maintaining them until January 2001, and then rapidly lowering rates.
• The Federal Reserve began raising interest rates in June 2004, and continued to do so at each subsequent policy meeting, while George W. Bush was facing a closely contested re-election battle.
• The Federal Reserve was lowering interest rates throughout 2008, and in the weeks leading up to the election, a severe financial crisis was triggered by a slowdown in the real estate market.
• In September 2012, as Obama sought re-election, U.S. officials introduced a controversial novel bond-buying stimulus plan.
• In September 2020, the Federal Reserve boldly committed to keeping rates low after the economy recovered from the impact of the pandemic, as concerns grew that the Fed might run out of ammunition.

Charles Evans said, "In my experience, the Federal Reserve acts quietly, thinks about what the right policy is, and when they need to make adjustments, they do what is necessary." Evans, a senior economist who later served as President of the Chicago Federal Reserve, participated in rate-setting meetings from 1995 to 2022