Source: Wall Street See

With inflation cooling down and potential signs of weakness in the labor market, Federal Reserve officials have reached a consensus that it’s almost time to cut rates. Investors hold the same view, and the market has fully priced in an expected 25 basis point rate cut by the Federal Open Market Committee (FOMC) at its September meeting. Product structure, operating income for products with 100-300 billion yuan is RMB 40.1/128.8/0.6 billion respectively.

However, some media outlets have analyzed that as U.S. monetary policy approaches a key inflection point, the next few months may be fraught with tension, and Fed Chairman Powell and his colleagues are now navigating between two relatively opposing risks. Although they want to eradicate inflation threats entirely, they also want to cut rates at an appropriate time and pace to prevent a quick deterioration in the labor market.

The focus of the market's attention is how fast the Fed will cut interest rates after September. There are concerns that if the action is too slow, it may create greater risk.

"Their concern is not just about the first two cuts, but the overall strategy for the next six to nine months," said Derek Tang, economist for LH Meyer/Monetary Policy Analytics. "Officials are asking, if an impact is imminent, where do we want to be?"

This suggests that the Fed may adopt a risk management strategy, which it often does during periods of high uncertainty. In other words, they look at two targets, assess where there is greater risk, and tend to deal with the larger risk first while also focusing on the other risk.

Disagreements within the FOMC

However, analysts believe that achieving this is not easy. Although the Fed has kept its benchmark rate in a range of 5.25% to 5.5% for more than a year, cooling inflation has caused real interest rates to rise. With slowing employment growth and cooling inflation, the FOMC now has differing views on where the maximum risk lies.

Among them, Fed Director Bowman and Atlanta Fed President Bostic advocate for a gradual rate cut. They want to see more evidence that price stability is in place and still believe that the labor market has some resilience. They point out that part of the reason for the rise in the unemployment rate is that job seekers are returning to the labor market. Moreover, while companies have reduced hiring, there has not been widespread layoffs.

For this group of people, analysis shows that Powell can cite the July inflation report to prove that a 25-basis-point rate cut in September is unlikely to cause inflation to rise. Excluding food and energy, the consumer price index rose 0.2% month-on-month in July, with a quarterly annualized increase of 1.6%, the lowest level since February 2021.

Currently, the unemployment rate has risen to 4.3%, so there are also officials who are concerned about the labor market and have set a certain "red line" for the unemployment rate. This group of people includes Mary Daly, President of the San Francisco Fed, who said on August 5, "We have now confirmed that the labor market is slowing down. It is crucial that we do not let it slow down too much, so as to avoid the economy slipping into recession."

Analysis suggests that in recent years, the U.S. economy has benefited greatly from a tight labor market, which has attracted many people into the labor force and raised wages, helping people resist inflation. However, this situation may quickly reverse, and the rise in the unemployment rate from 3.7% in January to 4.3% in July shows that if the economy slows down too much, the unemployment rate may continue to rise. Wage growth has slowed, and unemployment rates among African Americans and Latinos have risen since the end of last year.

"FOMC intentionally slows down the pace of economic growth to release the excessive pressure in the economy," said David Wilcox, former chief forecaster at the Fed and director of the Atlantic Economic Research Institute. "This vulnerability will only surface in this environment of weak growth."

Ensuring a soft-landing for the economy is Powell's top priority, and it may also involve his personal legacy. At the same time, the Fed's credibility is also being tested. Powell and his colleagues acted slowly in response to the surge in inflation, initially calling it "temporary." And if the economy falls into a recession due to prolonged high interest rates, it means that they have also missed an opportunity on the other hand, which will undoubtedly anger both parties in Congress and affect public sentiment.

Risk management strategy

Powell has hinted that he will take a risk management approach to help him get through the next few months. When considering the consequences of being wrong in two directions, history has shown that the greater risk may lie in employment. In addition to the new crown epidemic, the recent recession has had a profound and lasting impact on the labor market, especially low-income workers, as some people have exited the labor market, some of them permanently.

Given this, analysis suggests that the Fed may not only convey a path for rates to return to some balance or a neutral level for the economy, but may also convey a path aimed at offsetting those higher-cost risks. The market has already hedged against the latter possibility, with pricing showing that there may be a rate cut approaching one percentage point by year-end.

"The current major risk is that the weakness in the labor market may accelerate and the economy may unnecessarily decline," Wilcox said. "A 50 basis point rate cut should be their basic expectation for the first cut. The labor market doesn't need to soften any further."

Editor / jayden