A version of this post first appeared on TKer.co
The calls for the Federal Reserve to begin cutting interest rates sooner than later have been getting louder.
The resistance to these calls seems to be the suggestion that an initial rate cut would represent some monumental dovish shift in monetary policy at a time when concerns about inflation haven’t been fully put to rest.
But it’s not obvious to me that one rate cut is so big of a deal that it warrants some extraordinarily high hurdle for it to happen, especially with economic activity trends cooling.
‘Get on with it’
Inflation metrics have been coming down for two years and are now at levels that are just a rounding error away from the Fed’s 2% target rate.
Meanwhile, economic activity growth has been decelerating significantly, with labor market metrics normalizing. The economy has been looking a lot less “coiled,” with many signs of excess demand fading.
“Previously, with inflation far from its objective and employment closer to its objective, the Fed’s focus was on inflation,” BofA’s Michael Gapen said on Thursday. “Now, with smaller deviations in inflation and employment from target, the Fed’s attention can be more balanced. Cuts can happen because the economy cools, because inflation slows, or both.”
The risk of recession has been rising with economic growth slowing. Consumer spending growth plateauing and debt delinquencies rising are among the emerging warning signs. Notably, the unemployment rate has been ticking higher.
Taken altogether, it’s not surprising to hear Fed watchers argue for a rate cut.
“Get on with it,” says Renaissance Macro’s Neil Dutta, who has been out front among his peers with this call.
The Fed’s Federal Open Market Committee (FOMC) meets for its monetary policy meeting this coming Tuesday and Wednesday. While it’s unlikely that the central bank will announce a rate cut at the conclusion of this meeting, it may use it to signal future changes in policy.
“The Fed is getting closer to begin recalibrating monetary policy,” Dutta wrote in a note to clients on Monday. “Recent commentary strongly point to a September rate cut with July’s meeting being used to prep the markets that a series of cuts are on the horizon.”
Dutta isn’t alone in his call for the Fed to begin cutting rates soon.
“Markets are almost fully priced for a cut at the September 17-18 FOMC meeting, which remains our baseline forecast,” Goldman Sachs’ Jan Hatzius said earlier this month. “But we see a solid rationale for cutting as early as the July 30-31 meeting.”
Even former NY Fed President and longtime hawk Bill Dudley has made the case for a July rate cut.
“The Fed should cut, preferably at next week’s policy-making meeting,” Dudley wrote on Wednesday. “Although it might already be too late to fend off a recession by cutting rates, dawdling now unnecessarily increases the risk.”
While he hasn’t explicitly said anything about cutting rates in the coming months, Fed Chair Jerome Powell has recently acknowledged the growing risks to the economy.
“[I]n light of the progress made both in lowering inflation and in cooling the labor market over the past two years, elevated inflation is not the only risk we face,” Powell said in his testimony to Congress earlier this month. “Reducing policy restraint too late or too little could unduly weaken economic activity and employment.”
Monetary policy is not a light switch
While a first rate cut is arguably a historic milestone in the Fed’s fight to end the inflation crisis, I’m not convinced it’s as explosive of a market event as some pundits imply.
“I don’t think monetary policy is a ‘light switch,’” Dutta explained on CNBC. “It’s not on or off. The Fed can be nimble and flexible.”
I like this characterization because it addresses a nuance ignored in many discussions about rate cuts.
And I’ll take Dutta’s analogy a step further and say monetary policy is a “dimmer switch.” If your lights are on full power and you dim them by 5%, they’re still pretty bright, right?
Now take the Fed’s 5.25% to 5.5% target range for rates and cut it by 25 basis points.
The range is between 5% and 5.25%, indicating that monetary policy is slightly less tight but not loose. With inflation in check and economic data worsening, there may be more benefits than drawbacks to easing monetary policy. The concerns about a rate cut are exaggerated, as it is only a 25-basis-point reduction from a range of 5.25% to 5.5%, which is not as significant as past rate hikes. The current economic situation is more stable compared to previous years, making the upcoming Fed policy meetings less critical. It may be wise for the Fed to downplay the impact of a single rate cut and manage expectations for future policy changes. Overall, a single rate cut is unlikely to have a major negative impact, and historical context suggests it is not a major policy mistake. Since June 26th, the national average for gas prices has been around $3.50 per gallon.
Consumers are spending more, with personal consumption expenditures reaching a record annual rate of $19.44 trillion in June. Adjusted for inflation, real personal consumption expenditures also saw a slight increase.
Card spending data is mixed, with different reports showing varying trends in consumer spending.
Consumer sentiment remains guarded due to high prices, but labor market expectations are stable.
Unemployment claims have fallen, indicating continued economic growth.
Mortgage rates have ticked higher, affecting the housing market.
Home sales have fallen, but home prices have risen to record levels.
New home sales have also decreased, while offices remain relatively empty.
Survey data signals growth in the economy, with business investment activity on the rise.
Overall, the economy grew nicely in the second quarter. Based on the recent release of the Bureau of Economic Analysis data, the U.S. GDP grew at an annual rate of 2.8% in Q2, a significant increase from the 1.4% rate in Q1. Personal consumption also saw healthy growth at a rate of 2.3%.
While GDP calculations can sometimes distort the economic picture, economists often look at “final sales to private domestic purchasers” to gauge the true health of the economy. This metric, which excludes net exports, inventory adjustments, and government spending, grew at a 2.6% rate in Q2, remaining steady from Q1.
Most U.S. states are still experiencing growth, as indicated by the State Coincident Indexes report from the Philly Fed. The report showed that indexes increased in 40 states over the past three months and in 35 states in the past month.
Short-term estimates for GDP growth remain positive, with the Atlanta Fed’s GDPNow model projecting real GDP growth at a 2.8% rate in Q3.
It appears that the economy is following a bullish “Goldilocks” soft landing scenario, with inflation cooling to manageable levels without entering a recession. The Federal Reserve continues to implement tight monetary policy to control inflation, though it has taken a less hawkish tone in recent years.
While market conditions may remain challenging due to tight monetary policy, the overall financial health of consumers and businesses remains strong. This should help mitigate the risks of a recession, as consumers are finding employment and businesses have healthy finances.
Long-term investors should remain focused on their investment goals, as recessions and bear markets are part of the stock market’s inherent volatility. Despite recent market fluctuations, the outlook for stocks remains positive in the long run. The message needs to be provided in order to rewrite it. following sentence in a more concise manner:
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