"It's Time to Act": The Federal Reserve Delivers Significant Indication Regarding Its Upcoming Action
"It's time for policies to shift," as per Fed Chair Jerome Powell in his prepared speech for a gathering of central bankers and economists in Jackson Hole, Wyoming. "We're committed to supporting a robust labor market while continuing our journey towards price stability."
Powell expressed optimism about the US economy's potential for achieving a 'soft landing,' a seldom-observed occurrence where inflation diminishes without a significant surge in unemployment. This feat was accomplished only once, in the 1990s midway.
"With a reasonable easing of policy constraints, there's a solid reason to estimate that the economy will revert to a 2% inflation rate while maintaining a robust labor market," he mentioned.
Since commencing its aggressive interest rate hikes in early 2022, the Fed has propelled interest rates to their highest level in 23 years, an attempt to counteract the highest inflation in decades. The Fed's benchmark lending rate has remained stationary at its current level for a year, causing borrowing costs to escalate across various sectors, including mortgages and credit cards.
Despite the Fed's aggressive actions, the positive results are evident. Inflation has considerably decreased from its four-decade high, and while unemployment has risen marginally in recent months, the overall job market remains stable. The broader US economy has experienced solid growth this year, and the Atlanta Fed anticipates that growth hasn't declined. The Fed is successfully navigating the waters for a soft landing.
Following Powell's remarks, a potential interest rate reduction could be on the table for the Fed's upcoming policy meeting on September 17-18. American consumers have already experienced some relief due to falling bond yields, which are influenced by the Fed's interest rate decisions. Mortgage rates, which mirror the 10-year US Treasury yield, plummeted earlier this month.
"Things are looking promising," stated Tom Porcelli, chief US economist at PGIM Fixed Income, in his interaction with CNN. "The labor market is cooling, but it's not becoming soft. Household balance sheets are generally strong, particularly among high-income earners who account for the majority of aggregate spending."
A significant turning point
The Fed's decision to lower interest rates signifies that officials possess sufficient confidence that inflation pressures are lessening. A slowing job market is also contributing to the Fed's decision to reduce interest rates.
The Fed's preferred inflation indicator, the Personal Consumption Expenditures price index, registered an annual rate of 2.5% in June, significantly lower compared to the 7.1% observed two years prior. Powell attributed this progress to the "unwinding" of pandemic-related distortions to supply and demand, which initially fueled inflation globally post-Covid-19 pandemic.
Inflation reduced in the second half of last year as the broader US economy remained resilient. This was largely driven by improvements on the supply side, such as a larger workforce and improved supply chains. The US economy also underwent a noteworthy surge in productivity growth, which bolstered growth without driving up inflation. The job market's stabilization into a more typical state has also contributed to easing some price pressures.
"Our restrictive monetary policy has contributed to a moderation in aggregate demand, which in conjunction with improvements in aggregate supply, has reduced inflationary pressures while enabling growth to continue at a healthy pace," Powell stated in his speech. "As labor demand moderated, the historically high level of vacancies relative to unemployment has normalized primarily through a decline in vacancies, without significant and disruptive layoffs, resulting in a labor market state that no longer serves as a source of inflationary pressures."
Employer demand, as indicated by job openings, registered at 8.2 million in June, significantly lower than the record high of 12.2 million in March 2022. Wage growth has also moderated over the past few years.
The journey forward
The Fed has demonstrated significant progress in curbing inflation, but a soft landing is not yet guaranteed. The economy could prosper, or it could face challenges. Most economists don't anticipate a recession this year, but economic forecasts aren't always accurate.
Fed economists noted during their previous meeting that "the recent softening in some indicators of labor market conditions might be indicating a larger-than-anticipated slowdown in aggregate demand growth," according to minutes released earlier this week. Essentially, the recent weakening in the job market might result in American consumers cutting back on spending more than anticipated.
An uncertainty looms over the future of the US job market, which plays a pivotal role in the US economy. If job seekers encounter difficulties finding employment or worse, face layoffs, they'll likely reduce their spending. This signals a potential challenge because consumer spending makes up about 70% of the US economy.
The Fed and Wall Street are closely monitoring the health of the US consumer. Major retailers such as Home Depot and Lowe's have noted that American shoppers are spending more cautiously these days, opting for cheaper alternatives. However, it's been a mixed bag: Walmart reported better-than-expected financials for its latest quarter. US sales at America's largest retailer, which has been in operation for at least a year, increased 4.2% last quarter, and its operating income soared 8.5% during the quarter, as online sales expanded by 22%.
"The route for a gentle descent still exists, but it's becoming increasingly narrow as the job market softens, serving as a spending restriction, mentioned Elizabeth Renter, the senior economist at NerdWallet."
In light of Powell's optimism about a potential soft landing for the US economy, business owners might see an opportunity to invest and expand their operations with the anticipated decrease in borrowing costs. The overall economic stability and the decreasing inflation rate are indicative of a healthy business environment.
As the Fed considers a potential interest rate reduction, the impact on the economy, particularly on the housing market and consumer spending, will be closely monitored. A lower interest rate could stimulate economic growth and boost consumer confidence, ultimately benefiting various sectors of the economy, including businesses.
