Will Interest Rates Soon Get Cut?

Federal Reserve Chair Jerome Powell (“Powell”) gave a much-anticipated speech recently at the Jackson Hole Economic Symposium — the invitation-only summit hosted each year by the Kansas City Federal Reserve.

In his keynote address, Powell examined the current economic situation for the nation and outlined the path ahead for monetary policy. 

Inflation has Fallen, and the Labor Market Improved

The focus of the Federal Open Market Committee (“FOMC”) has been to bring down inflation, Powell said. Over time, the restrictive monetary policy currently in place should return inflation to the Fed’s 2% target. Noting that inflation has fallen to 2.5% from a peak of 7.1% two years ago, Powell indicated that he is confident that “inflation is on a sustainable path back to 2 percent.”

His speech emphasized that the labor market has “cooled off” and is no longer “overheated.” Hiring rates and the rates of workers quitting the market have dropped below the levels that prevailed in 2018 and 2019. Nominal wage gains have moderated, and the unemployment rate — currently at 4.3 percent — is still low by historical standards. This is almost a full percentage point above what it was in 2023. According to Powell, unemployment this year has not been due to layoffs, but because the frantic pace of hiring seen earlier has slowed down.  

All in all, he said, the outlook of the labor market is less “tight” than it was just before the pandemic in 2019. In other words, the gap between the number of workers and available jobs is narrowing. 

Further, Powell appeared confident the Fed would be able to achieve a “soft landing” — a slowdown of economic growth without causing a recession. He expects inflation to get back to 2% while maintaining a strong labor market.

The Fed Got it Wrong

During his speech, Powell admitted he and his colleagues underestimated the effects the COVID pandemic would have on the economy — and that they misjudged the inflationary threat when it emerged in 2021. Following standard thinking, the Fed expected the pandemic-related factors to have a short-lived effect. 

The “common expectation was that supply conditions would improve reasonably quickly, that the rapid recovery in demand would run its course, and that demand would rotate back from goods to services, bringing inflation down.” 

Distortions in demand and supply caused by the pandemic, along with severe shocks to the energy and commodity industries, drove inflation up. Unfortunately, it took a lot longer than expected for these effects on inflation to unwind. 

Ultimately, however, the lessening of the effects of the pandemic, coupled with the Fed’s efforts to moderate aggregate demand, and the anchoring of expectations, have all brought about the public’s confidence that, in time, the central bank will bring inflation down to about 2%.

In all fairness to the Fed, and as Powell pointed out in his speech, the pandemic was an unprecedented event that no one was prepared for. The pandemic economy has proved to be an economy unlike any other — making it difficult to accurately navigate COVID’s economic impacts. 

Expect to See Rate Cuts 

For six straight meetings, the Federal Open Market Committee (“FOMC”) has kept rates unchanged. While Powell indicated that it will take longer than expected to bring inflation to the Fed’s 2% goal, he did provide indications that interest rates will soon be coming down. When this would happen, or how deep those cuts would be, he did not say. Yet his message was clear:

“The time has come for policy to adjust. The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks.”

Investors now expect that the FOMC will begin to cut rates at its next meeting on September 18.

A Humble Closing

Powell ended his remarks by emphasizing that, having made mistakes during the pandemic, the Fed will review its principles and make adjustments through public review every five years. In addition, he indicated that the Fed has been humbled by the pandemic experience, in which the Fed’s belated rate hikes did not cause a painful recession as expected. Thus, in the future, the Fed will be:

“…open to criticism and new ideas, while preserving the strengths of our framework. The limits of our knowledge—so clearly evident during the pandemic—demand humility and a questioning spirit focused on learning lessons from the past and applying them flexibly to our current challenges.”

The rate cuts virtually assured in Powell’s speech presage generally good news for investors and borrowers. Nevertheless, experts agree that the timing and pace of those cuts depends on labor market conditions and incoming data. As a result, investors may want to keep a close eye on all upcoming economic data because this will continue to influence the Fed’s policy decisions. 

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