Fed Watch – September cut likely
Powell: “‘Certainty’ is not a word that we have in our business.” But a September cut is likely. As expected, the Fed voted unanimously to keep monetary policy on hold. While the policy statement remained relatively balanced, Powell's replies in the press conference were decidedly more doveish, clearly preparing the ground for a 25bp September cut, while leaving room to further delay the easing cycle if inflation proves more sticky.
The policy statement contained a number of carefully re-written elements. The most important is the explicit mention of the two-sided objective, noting that the 'Committee is attentive to the risks to both sides of the dual mandate,' whereas in June, they only mentioned inflation risks. Further changes were the first acknowledgement of the recent softening of the labor market. A notable lack of change was on the language regarding the need for 'greater confidence' about the disinflationary trajectory. Overall, the statement makes it clear that the two objective goals are moving into better balance, which implies they are closer to the point where they could cut rates. While there is no explicit hint on a rate cut, the changes in the statement are certainly consistent with a preparation for a September move.
The press conference further laid out this preparation. In an increasingly dovish performance Chair Powell pushed two main ideas. The first is that he sees the weakening of the labor market as a `normalization,' the second that a September cut is on the table, but not yet set in stone.
Powell highlighted that the economy is currently in a good place, given restrictive monetary policy. He sees no reason to think the economy is overheating, nor to think that it's sharply cooling. Growth and final private demand remain strong. The labor market is softening but the unemployment rate is still at historic lows, despite the recent rise, and job creation is moderating but still solid. Importantly, inflation continues to come down. Here he noted that the recent inflation readings were of higher quality than similar readings in the second half of last year. While last year's figures were driven by goods deflation - given as a reason they refrained from easing then - now the disinflation is much more broad-based, with both housing- and non-housing services following suit. Powell further set the stage by commenting on the reaction function in this context, noting that with the labor market cooling, upside risks to inflation were receding, while downside risks to employment were increasing. So despite the fact that inflation is still further from target than employment, it is time to shift more weight to the full employment mandate.
This was further confirmed by discussions on a possible September cut. Powell noted that a discussion had taken place to already cut this meeting, but that 'a strong majority' supported not yet moving in this meeting. September is certainly in play. Powell tried to paint some scenarios in which a cut would indeed happen, noting that high inflation would prevent a rate cut, but a scenario where things develop in line with expectations would almost certainly entail a cut. Effectively, Powell laid the groundwork for a September cut, but gave some room to delay if the data turns. Powell laughed off the suggestion of a 50bp cut, despite market pricing suggesting the chance of such a move (albeit low).
A final comment of note regarded the Fed's response to the election, in which he explained that they too could run simulations of various policy scenarios, but that they would never make a decision on the basis of an outcome of an election that hasn't happened yet.
Overall, we see Powell’s remarks today as a confirmation of our base scenario with an initial rate cut in September.