Anika Begay
Last week’s deluge of data left behind a few distinct impressions: inflation is on the run, the labor market appears OK if not on fire, and the economy is not headed for a cliff edge despite the lingering potential for a substantial slowdown. This is the backdrop for a decidedly critical period for Federal Reserve policymakers. It begins next week with the central bank’s annual conclave in Jackson Hole, Wyoming, continues into the first week of September with a seemingly decisive jobs report, then winds through more vital economic data and concludes with the Fed’s September 17-18 policy meeting. First up: Chairman Jerome Powell’s policy speech next Friday to cap off the Jackson Hole event, where he is expected to at least sketch out — in pencil, not pen — the likely course forward, with plenty of flexibility so that the Fed doesn’t get fooled again, as it did in the early days of the inflation surge. “They still want to give themselves some space. We have to remember that the Fed made a mistake, the transitional call” on inflation, said Quincy Krosby, chief global strategist at LPL Financial. “That mistake is in the history books. They were too late for what they should have done. They don’t want to make a mistake on that side of the equation.” In particular, the Fed is grappling with how quickly and aggressively it should respond now that the inflation rate is falling. Here’s what we learned from the latest rapid-fire round of data: Consumer price increases have slowed to the weakest pace in more than three years, wholesale prices barely rose in July, spending has proven much more resilient than expected, and layoffs, after a brief spike a few weeks ago, are close to their long-term trend. To be sure, not all the news has been good: Housing remains a weak spot for the economy and looks set to get worse, judging by the start of lockdowns and furloughs hitting a four-year low in July. Wages are rising, but only 0.7% faster than inflation. And if you’re looking for inflation, it’s showing up in imports, where the annual pace of price increases has hit its highest level since December 2022, though still only 1.6%. Ready to Ease Still, markets overall widely believe the Fed can — and should — start lowering interest rates next month. “This is not an exact science. It’s probably as much of an art form as a science,” Krosby said. “The longer they wait, the more problems they’re going to have. There’s going to be different problems, but they’re going to have problems.” Market prices Friday afternoon were pointing to about a 3-to-1 chance of a quarter of a percentage point, or 25 basis points, of a cut in September, according to CME Group’s FedWatch indicator of federal funds futures contracts. From there, traders are looking for another similar move in November and December, with the final cut this year likely to be half a point. The bigger worry now is that the Fed will cut because it wants to guide the economy to a much-vaunted soft landing, rather than having to act drastically because it has to, i.e. if the labor market collapses or some other crisis occurs. “The market wants it to be commensurate with the inflation that’s coming down, not an emergency rate cut,” Krosby said. “The primary fear for the market is that we have a recession, and not a shallow recession but a deep recession that completely changes the equation.” Former Fed Vice Chairman Richard Clarida, a self-described “founding member of the transition team” during his tenure, said he thought the most likely path now was a quarter-point cut in September. However, he also predicted that the August nonfarm payrolls report, due in early September, would have a disproportionate impact, despite Powell stressing that the Fed is “data dependent” rather than “data point dependent.” “Jay Powell says they don’t want to be data-dependent, and I think that makes sense. But I would point out that I think there’s a special importance in what we hear about the labor market,” Clarida said in an interview with Vscek on Friday. “If it’s a dire report, negative payrolls and a big increase in employment, then we’re going to go to 50. So I think it’s data-dependent for that first move.” The Case for Not Cutting To be sure, not all market participants are on board with a reduction. Even with an increased emphasis on the jobs picture, Powell and other Fed officials are still unlikely to declare a complete victory on inflation, and for good reason, said Komal Sri-Kumar, head of Sri-Kumar Global Strategies. While aggregate inflation numbers are falling, housing costs continue to defy expectations of a downward trend, and the strong 1% increase in retail spending in July suggests that consumers are enduring high interest rates, itself an inflationary trend. “Yes [cut] because inflation is below target… The second reason you should cut is because the economy is weak,” Sri-Kumar said. “Where is the weakness? I don’t think there’s any signs of weakness in the economy. There’s no signs of inflation being under control and you don’t have any signs for the Fed to change its focus.” However, Sri-Kumar said he expects the Fed to cut anyway and for Powell to send a strong signal to Jackson Hole that easier policy is on the way. “He’ll probably essentially give his indication, not only of that, but also pat himself on the back for being successful in significantly reducing inflation,” he said. “So the big market rally doesn’t have to wait until September 18th. It’s already started and he could give him another piece of stimulus when he speaks in Jackson Hole.”
