Fed: Powell opens the door to a rate cut in September

(Il Sole 24 Ore Radiocor) - The signal that financial markets were expecting has arrived: the Fed now sees the conditions to return to cutting interest rates as early as the next meeting in September. Delivering the message was the president of the US central bank, Jerome Powell, in his eagerly awaited speech in Jackson Hole, Wyoming where he pointed out how the balance of risks between employment and inflation has now shifted and this opens the door to a change in monetary policy stance. "In the short run," Powell said, "the risks to inflation are tilted up, while the risks to employment are tilted down: a challenging situation. "When our objectives come into tension with each other our policy framework requires us to balance both sides of the dual mandate. Our policy rate is now 100 basis points closer to neutral than it was a year ago, and the stability of the unemployment rate and other labour market indicators allows us to proceed cautiously as we consider possible changes in monetary policy stance. Nonetheless, with monetary policy in restrictive territory, the baseline scenario and the changing balance of risks may make it necessary to adjust our monetary policy stance'. All this of course on the basis of a careful assessment of the data and without committing to a predefined path on rates. "Monetary policy does not follow a predetermined path. FOMC members will make these decisions solely on the basis of their assessment of the data, the implications for the economic outlook and the balance of risks. We will never deviate from this approach."

An important passage Powell devoted to the impact that the tariffs imposed on trading partners by the Trump administration are having on inflation, and, perhaps surprisingly, Powell indicated that he thought it plausible that this impact would be short-lived. "Gthe effects of tariffs on consumer prices are now clearly visible," he explained, "We expect these effects to accumulate over the coming months, with high uncertainty about the timing and magnitude. The relevant question for monetary policy is whether these price increases are such that the risk of persistent inflation increases significantly'. "A reasonable underlying assumption is that the effects will be relatively short-lived - a one-off shift in the price level. Of course, 'one-off' does not mean 'all at once'. It will still take time before tariff increases are transmitted along supply chains and distribution networks. In addition, tariffs levels continue to evolve, which could prolong the adjustment process'. However, it is also "possible that upward price pressures from tariffs will trigger a more lasting inflationary dynamic and this is a risk that needs to be assessed and managed". One possibility is that workers, seeing their real incomes fall due to higher prices, demand and obtain wage increases from employers, initiating unfavourable wage-price dynamics. "Given that the labour market is not particularly tight and faces increasing downside risks, such an outcome does not seem likely, however".

Powell, who has long been under constant pressure from the White House to cut rates sharply, defended the line the central bank has taken so far. "When I stood at this podium a year ago, the economy was at a turning point. Our reference rate had remained at 5.25-5.5% for over a year. That tight monetary policy stance was appropriate to help reduce inflation and foster a sustainable balance between aggregate supply and demand. Inflation had moved much closer to our target and the labour market had cooled from its previous overheated condition. The upside risks for inflation had been reduced. However, the unemployment rate had risen by almost one percentage point, a development not historically seen outside recessions. Over the course of the next three Federal Open Market Committee meetings, we recalibrated our monetary policy stance, setting the stage for the labour market to remain in balance near full employment over the past year. This year, the economy faced new challenges. Significantly higher tariffs among our trading partners are reshaping the global trading system. A more restrictive immigration policy has led to an abrupt slowdown in labour force growth. In the long run, changes in tax, spending and regulatory policies could also have important implications for economic growth and productivity. There is considerable uncertainty about where all these policies will eventually stabilise and what their lasting effects on the economy will be'.

Powell finally announced the results of the strategy review that is conducted every five years. According to the chairman's announcement, the Federal Reserve abandoned the average inflation targeting strategy adopted in 2020, which consisted of allowing upward price overshootings if prices had been below target in the previous period, i.e., a compensation system. "We have returned to a framework of flexible inflation targets and have eliminated the 'compensation' strategy. As it turned out, the idea of an intentional moderate inflation overshooting proved to be irrelevant. There was nothing intentional or moderate about the inflation that occurred a few months after the announcement of the 2020 changes'. An announcement that was in the air and strongly hoped for by many economists who argued that this stance wasted the Fed's precious time as inflation spiked in the wake of the pandemic and the war in Ukraine, forcing it to race to make up for lost time by raising the cost of money by 525 basis points over the course of 16 months.