The Federal Reserve is in a pickle. No, not the delicious, crunchy kind you crave at a deli. We’re talking a pickle of the economic variety, a situation so sour it could curdle your financial outlook. They raised interest rates to cool things down, but now they’re worried about over-refrigerating the economy and turning everything into a popsicle. Will they cut rates and risk a reheating of inflation? Or will they stay the course and risk a deep freeze? Buckle up, because this isn’t your grandma’s recipe for economic prosperity. We’re about to explore the Fed’s culinary conundrum, where the stakes are higher than a gourmet chef’s reputation – they hold the fate of the entire economic meal.
TL;DR
- The Fed raised interest rates to control inflation and cool the labor market.
- Now they’re worried about slowing down the economy too much.
- Data suggests a rate cut might be needed, but past mistakes make them cautious.
- The Fed weighs the risks of inflation vs. recession.
The Federal Reserve raised interest rates above 5% a year ago, with two main goals: taming inflation and cooling down the labor market.
And guess what? They’ve done it. Inflation, by the Fed’s preferred gauge, has plummeted from 4.3% to an estimated 2.6%. That’s the steepest decline since 1984, nearly hitting the Fed’s 2% target. Meanwhile, unemployment has ticked up to 4.1% from 3.6%, an increase rarely seen outside of recessions.
Yet, the Fed seems hesitant to celebrate. This week, Fed Chair Jerome Powell refused to commit to a timeline for cutting interest rates. New York Fed President John Williams claimed he needed more data, and Fed governor Chris Waller just hinted that a cut was “getting closer.” Markets expect a cut in September.
The Fed’s hesitation is understandable. It prefers to signal its plans well in advance, especially after its previous inflation forecasts missed the mark. But if the Fed were genuinely data-dependent and confident in its forecast, it would be ready to cut interest rates now. At the very least, this option should be on the table at their upcoming meeting. While cutting rates has its risks, so does waiting. Here’s how the Fed should weigh those risks.
Once Burned on Inflation, Twice Shy
The Fed’s caution stems from its infamous 2021 prediction that inflation would be transitory. Back then, GDP was still below pre-pandemic levels, and unemployment was above its long-term “natural” level. According to models used by the Fed and private forecasters, this slack meant that even massive fiscal stimulus shouldn’t have pushed inflation up much, especially since public expectations of inflation were anchored at around 2%.
However, forecasters missed how the pandemic had disrupted supply chains and work patterns, driving millions from the labor force. When stimulus-fueled demand hit these supply constraints, prices soared. Wages soon followed. As unemployment plunged below 4% and vacancies soared, the Fed feared a wage-price spiral and jacked up interest rates to 5.25% to 5.5%, where they stand today.
Higher rates cooled demand, but inflation mainly fell due to recovering supply chains and receding fiscal stimulus. The shocks of recent years have left prices and wages higher, but their impact on ongoing inflation has proved mostly temporary.
As a result, the interest rates that seemed appropriate a year ago now appear too high. Economists have devised several simple formulas, such as the “Taylor Rule,” to guide monetary policy, and they suggest rates ought to be lower.
The Risks of Waiting
Overall economic growth has decelerated gently to around 2% this year, which is still healthy. Unemployment at 4.1% suggests the labor market is balanced. The stock market is at a record high. On the surface, this doesn’t look like an economy in dire need of lower rates.
But there are warning signs. Historically, when unemployment rises this much, it tends to keep climbing. The increase might reflect a rising supply of labor, likely from migrants lacking permanent legal status. Labor demand looks solid, with monthly job growth above 200,000 based on the Labor Department’s payroll survey. However, its separate household survey shows weak job growth, leaving the true picture unclear.
High interest rates haven’t slowed growth much because many homeowners and businesses locked in low rates. But stress is building: credit card and auto loan delinquency rates are now above pre-pandemic levels.
The Risks of Cutting
The biggest risk of cutting rates now is that inflation might not be fully defeated. Yet, a reacceleration seems unlikely. With hindsight, the shocks of recent years triggered one-time price boosts. For instance, semiconductor shortages caused auto production to plunge in 2021, driving prices up. New-car inflation peaked in early 2022, followed by repairs and maintenance costs, and car insurance costs.
These ripple effects have made inflation’s downward path bumpy and the underlying trend hard to discern. However, such shocks can’t sustain inflation without other conditions, particularly a tight labor market, which no longer exists.
Vacancies have fallen from a record two per unemployed worker in early 2022 to a more normal 1.2 now. Unemployment is rising. Annual wage growth has dropped from 5.9% in March 2022 to 3.9% in June and is expected to fall further next year, according to a survey of companies’ pay plans by WTW, a consulting firm.
While inflation might not reaccelerate, there’s a risk it will stall around 2.6% rather than falling to 2%. Indeed, the 12-month inflation rate might tick higher soon as low readings from a year ago drop out of the calculation.
If that happens, the Fed can simply refrain from cutting rates again. That’s what being data-dependent means. Rates would still be at a restrictive level.
No-Win Politics
Fed officials insist the upcoming election doesn’t influence their decisions. Understandably, no matter what they do, one party will be upset. Republican candidate Donald Trump indicated in an interview with Bloomberg that the Fed shouldn’t cut at all between now and the election. Democrats will similarly lash out if the Fed doesn’t cut.
Still, Goldman Sachs chief economist Jan Hatzius suggested that to the extent politics play a role, they argue for making the decision as far from the election as possible—i.e., now, not in September.
Currently, the odds are the Fed won’t cut rates in two weeks but will signal readiness to do so in September. That should keep markets calm. But an actual cut and an expected cut aren’t the same thing. Economists surveyed by The Wall Street Journal put the probability of a recession in the coming year at 28%—not high, but higher than normal. If that risk materializes, even a few months’ delay will have mattered.
Recent Events Supporting the Case for an Immediate Fed Rate Cut
June 2024 Inflation Report:
- Description: The Consumer Price Index (CPI) showed a year-over-year increase of just 2.6% in June 2024, continuing the trend of declining inflation rates.
- Source: U.S. Bureau of Labor Statistics
May 2024 Jobs Report:
- Description: The U.S. economy added 209,000 jobs in May 2024, but the household survey indicated only modest gains, showing inconsistencies in labor market data.
- Source: U.S. Bureau of Labor Statistics
June 2024 Unemployment Rate:
- Description: Unemployment rose to 4.1%, suggesting a cooling labor market. This increase in unemployment is rarely seen outside of recessions.
- Source: U.S. Bureau of Labor Statistics
Q2 2024 GDP Growth:
- Description: The economy grew at an annual rate of 2% in the second quarter of 2024, a healthy pace but slower than previous quarters, indicating a gentle deceleration.
- Source: U.S. Bureau of Economic Analysis
Credit Card and Auto Loan Delinquency Rates:
- Description: Delinquency rates for credit cards and auto loans have risen above pre-pandemic levels, indicating financial stress among consumers.
- Source: Federal Reserve Bank of New York
Federal Reserve’s June 2024 Meeting Minutes:
- Description: The minutes highlighted the Fed’s concerns over waiting too long to adjust rates, as several members expressed the need to consider a rate cut sooner rather than later.
- Source: Federal Reserve
My take on the above points
- Inflation Data: The June 2024 CPI report indicates that inflation is steadily declining, approaching the Fed’s target of 2%. This supports the argument that high-interest rates are no longer necessary to control inflation.
- Jobs Report: The mixed signals from the May 2024 jobs report, with strong payroll numbers but weak household survey data, highlight uncertainties in the labor market. This inconsistency suggests that a more nuanced approach, such as a rate cut, might be warranted.
- Unemployment Rate: The rise in unemployment to 4.1% is a significant indicator of a cooling labor market, typically not seen outside of recessionary periods. This uptick reinforces the need for a proactive rate cut to prevent further economic slowdown.
- GDP Growth: The Q2 2024 GDP growth rate of 2% shows a healthy economy but also hints at a gentle deceleration. Maintaining economic momentum might require a rate cut to foster continued growth.
- Delinquency Rates: Rising delinquency rates for credit cards and auto loans signal increasing financial stress among consumers. This trend underscores the potential risks of maintaining high-interest rates, which could exacerbate financial difficulties.
- Fed Meeting Minutes: The June 2024 meeting minutes reveal internal Fed discussions about the potential benefits of cutting rates sooner rather than later. This internal debate aligns with the article’s argument for immediate action to avoid unnecessary economic risks.
These recent events collectively support the argument that the Fed should consider cutting interest rates now rather than waiting until September. The data and discussions highlight the potential risks of inaction and the benefits of a proactive approach to monetary policy.
My Perspective
I think the Fed is caught between a rock and a hard place. On one hand, they’ve managed to bring inflation down and cool the labor market. On the other, they’re hesitant to declare victory and cut rates due to past forecasting blunders and the potential political fallout.
From my point of view, the data suggests it’s time to cut rates. The risks of waiting—higher unemployment, slowing growth, and rising delinquencies—outweigh the potential for a slight uptick in inflation. Plus, if inflation does start to climb again, the Fed can always hit the brakes. It’s like trying to drive with one foot on the gas and the other on the brake—eventually, you have to pick a direction.
The Fed should take a bold step and cut rates now. This move would signal confidence in their data and forecasts, provide a cushion against rising unemployment, and help sustain economic growth. After all, isn’t it better to be proactive rather than reactive?
Will the Fed cut rates and risk a sprinkle of inflation, or remain firm and risk a full-blown economic soufflé collapsing? The answer, my friends, is as uncertain as the stock market itself. But one thing’s for sure: the Fed’s next move will be a recipe for conversation, debate, and maybe even a few financial heartburn medications. Want to stay ahead of the curve and avoid economic indigestion? Dive deeper into our “Finance” category for more insights (and maybe a few laughs) on the Fed’s culinary capers!
