Fed leader tees up interest rate cuts in search of soft landing
After a near-textbook campaign to rein in inflation by raising interest rates, the head of the Federal Reserve, Jerome H. Powell, all but promised Friday to start lowering rates next month — with fingers crossed that it’s not too late to avoid a recession.
From the beginning of the inflationary surge triggered more than three years ago by the economic disruptions of the pandemic, it was clear that raising interest rates could tame price increases. It was also clear that, if rates stayed too high too long, they could choke the economy into recession.
And few states are showing stronger signs of a possible downturn than California, which has felt the effects of high interest rates more severely than others. Not only has its unemployment rate been among the highest in the land while its job creation rate lagged, but pillar industries such as entertainment and tech have also gone through major disruption and many residents and businesses have left the state.
“Overall, the economy continues to grow at a solid pace,” Powell said in a widely anticipated speech at the annual summer symposium of central bankers in Jackson Hole, Wyo. “But the inflation and labor market data show an evolving situation. The upside risks to inflation have diminished. And the downside risks to employment have increased.
“The time has come for policy to adjust,” he said, giving the strongest signal yet of an imminent rate cut.
Investors cheered the news. Major stock indexes rose almost immediately after he began speaking.
Powell did not tip his hand on the size of the coming rate cut, but most analysts expect a small quarter-point move next month and a succession of similar reductions over the next year.
But Powell’s emphasis on doing “everything we can to support a strong labor market” gave some economists reason to think that the Fed could make a half-point move next month. Powell said that the pace of policy actions would “depend on incoming data, the evolving outlook, and the balance of risks.”
Whatever the initial size may be, it should fairly quickly nudge down interest rates on credit cards, auto loans and other consumer financing, but the broader economic effects of Fed policy are likely to take hold only gradually.
And with the political climate at a boil and the U.S. unemployment rate rising significantly since the start of the year, the Fed may find itself behind the curve in reversing course after what has been, up to now, a successful run of lowering inflation while preventing the economy from falling into a recession — the so-called soft landing.
“They’ve got to get going,” said Mark Zandi, chief economist at Moody’s Analytics, who for months has been calling on the Fed to start lowering rates.
Barring major economic changes or extreme volatility in markets, most economists see two to three quarter-point cuts this year and several more over the course of 2025, eventually bringing the Fed’s benchmark rate from the current two-decade high of 5.3% down to around 3%.
Financial markets have already priced in a September quarter-point cut, with stocks having mostly recovered from a big jolt a couple of weeks ago when investors feared the economy was turning down quickly and that the Fed was already too late.
Interest rates for a conventional 30-year mortgage were down to a hair below 6.5% this week, from more than 7% as recently as May. Lower rates should also help with auto purchases. Zandi said car sales have slowed as consumers have been waiting for better rates. The average interest rate on a five-year new auto loan was 8.2% in the second quarter, the highest since the Fed’s recordkeeping began in 2006.
The overriding question with the economy is jobs, both for workers and for political leaders facing a national election in November. And jobs are one of the two basic elements of the Fed’s responsibility. The other is price stability.
Powell acknowledged on Friday that the Fed initially misjudged the inflation surge in spring 2021, thinking that the pandemic-related surge in prices would be “transitory” and one that the Fed could look past.
Most analysts criticized Fed officials for waiting too long to raise rates, but Powell noted that they were hardly alone. “The good ship Transitory was a crowded one,” he said, adding in impromptu remarks, “I think I see some former shipmates out there today,” prompting a moment of laughter from the audience during his 15-minute speech.
It wasn’t until March 2022 that the Fed began raising rates. And, until recently, Powell and his colleagues focused squarely on consumer price inflation, which peaked in June 2022 at 9.1% and has since dropped to just under 3%. With inflation now trending toward the Fed’s 2% target, the central bank’s attention has turned to employment, which has become more worrisome in recent weeks.
First-time unemployment claims have moved up while the number of job openings has shrunk. The nation’s unemployment rate, 4.3% in July, is up from 3.7% in January, and new reports this week indicate that job growth from March 2023 to March 2024 was considerably smaller than previously estimated, though still healthy.
“The cooling in labor market conditions is unmistakable,” Powell said, adding, “We do not seek or welcome further cooling in labor market conditions.”
California’s unemployment rate has held steady in the last three months at 5.2%, but that’s still the second-highest in the country after Nevada. (California earlier in the year had the highest jobless figure.) More recently the pace of job growth in California has picked up, but the July report from the state’s Employment Development Department shows workers in California on average are putting in fewer hours of work.
That may not be a bad thing if more workers are opting for a better work-life balance, something that has become more important since the pandemic, said Erica Groshen, an economist and former commissioner of the U.S. Bureau of Labor Statistics. And, longer term, it could mean companies are more productive if they’re producing as much or more with less labor.
But the decline in work hours, she said, could signal weakening demand and pending layoffs if business conditions persist or worsen.
The latest data from the state EDD show average weekly hours of work for all private-sector employees was down to 33.4 hours in July, from 34.5 a year ago. That may not seem like much, but it means a significant corresponding drop in average weekly earnings, which turned negative in July compared with a year earlier. Workers in information, education and health services, professional and business services, and the leisure sector posted fewer hours of work.
“The softening job market tends to go with reduced hours,” said Sung Won Sohn, professor of economics and finance at Loyola Marymount University. “Typically, firms start cutting back hours before shedding jobs.”
That probably is even more true now because over the last several years many employers have had trouble finding new workers when they needed them.
Tom Trujillo, president of a family-owned business that operates eight Wienerschnitzel restaurants in the Southland, has held on to his staff of about 140. But like many other fast-food franchisees, Trujillo said he has cut back on overtime and some part-time employees’ hours as a result of the $20 minimum wage that took effect in April for his industry.
In response, he said, he’s raised prices and some of his stores are opening a little later and some dining rooms closing an hour or two earlier.
“I have a reserve credit line, with a zero balance,” Trujillo said. “The lower interest rates would be nice if I have to draw on that.”
But what he said he needs most today are more customers and for them to come more often.
Whether lower interest rates could help drive greater sales at Trujillo’s and other businesses remains to be seen.