US Fed Signals Rate Cut: A New Era of Monetary Policy?

Senior officials of the U.S. Federal Reserve have indicated their intention to lower interest rates, providing potential relief for American borrowers for the first time since the inflation surge caused by the COVID-19 pandemic. In public appearances this week, including congressional hearings featuring Fed Chairman Jay Powell, U.S. central bankers expressed increased confidence about their control over inflation and their readiness for a policy shift. Their conviction was bolstered by better-than-expected economic data that confirmed a persistent reduction in consumer price pressures. Simultaneously, a weakening of the labor market was observed. U.S. banks also warned that low-income customers are increasingly showing signs of financial strain. Although decision-makers did not specify when and to what extent they would reduce borrowing costs, their rhetoric was clear: A new era has begun. Traders and economists generally expect the first rate cut in September—something Tiffany Wilding of Pimco described as a 'done deal' following recent data. Austan Goolsbee, President of the Chicago Fed, told the Financial Times that it had been a 'good week' for the central bank, which has been trying to lower inflation without triggering a recession. 'I definitely feel better than I did on Monday,' said Goolsbee. 'Not just this week, but data from the past two or three months point to a continued rapid and significant decline in inflation that we've seen in 2023.' He added that the drop in inflation meant that real interest rates have automatically become more restrictive. 'We've already tightened significantly in real terms while we've waited. You want to be restrictive only as long as necessary. When it’s no longer needed, I think it’s appropriate to return to a normalized stance.' Since last July, the Fed has maintained its benchmark interest rate at a 23-year high of 5.25-5.5 percent. Powell explained to lawmakers that, due to 'substantial progress' in curbing price pressures and the apparent cooling of the labor market, the Fed no longer needs to be primarily focused on inflation. Instead, the central bank is facing 'two-sided risks' and must be careful not to inadvertently cause excessive job losses due to high interest rates. Mary Daly, President of the San Francisco Fed and a voting member in 2024, later confirmed that a rate cut is 'justified.' A well-managed inflation is underpinned by a strong but not overheated labor market, Powell said. With an unemployment rate above 4 percent and slowing wage growth, the labor market no longer contributes to price pressures. Without careful policy coordination, the gains made since the pandemic could be at risk. Powell emphasized before the House Financial Services Committee that this 'is the most important thing that keeps him up at night.' Fed Governor Lisa Cook also highlighted how 'very attentively' the Fed is responding to changes in the unemployment rate. The Fed aims for a 'soft landing,' where inflation falls to the target without a significant rise in layoffs. This requires the Fed to soon begin easing and bring policy rates closer to 3 percent over time, according to Priya Misra of JPMorgan Asset Management. Jonathan Pingle of UBS added that the economy and the labor market are indeed slowing down. 'At some point, they will want the downturn to stop and stabilize, but the risk is that it continues.'