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Federal Reserve officials have given the strongest signal yet that they are preparing to cut interest rates, offering relief to long-strapped American borrowers for the first time since inflation in the world’s largest economy exploded in the wake of the coronavirus pandemic.
In public appearances this week — including two congressional hearings for Chairman Jay Powell — U.S. central bankers spoke with renewed certainty about their control of inflation and their willingness to make a policy shift.
Their conviction was bolstered by better-than-expected economic data this week, which confirmed a continued decline in consumer price pressures, accompanied by a softening labor market. At the same time, U.S. banks have warned that lower-income customers are showing signs of financial stress after a prolonged period of high prices.
While policymakers declined to specify when and how much they would cut borrowing costs, their rhetoric made clear that a new era is dawning. Traders and economists widely expect the first cut in September — something Pimco economist Tiffany Wilding called a “done deal” after this week’s data.
Chicago Fed President Austan Goolsbee told the Financial Times on Friday that it had been a “good week” for a central bank aiming to lower inflation without triggering a US recession.
“I definitely feel better [now than on Monday]”, Goolsbee said. “It’s not just this week, but the data over the last two to three months points to a continuation of what happened in 2023, which was a rapid and very significant decline in inflation.”
Goolsbee added that the fall in inflation meant that real interest rates were now automatically more restrictive. “We tightened real interest rates quite a bit while we were waiting. You only want to be that restrictive for as long as you need to be. When you don’t need to be, I think it’s the right time to get back to a more normalized stance.”
Since July last year, the Fed has kept its key policy rate at 5.25-5.5 percent, the highest level in 23 years.
Powell laid the case out to lawmakers earlier this week, telling them that the Fed does not need to focus primarily on inflation as “significant progress” has been made in tamping price pressures and the labor market is showing clear signs of cooling.
Instead, the central bank was faced with “two-sided risks” and had to be more aware of inadvertently causing excessive job losses by continuing to bombard the world’s largest economy with high interest rates.
His comments were backed up by those of Mary Daly, president of the San Francisco Fed and a voting member through 2024, who told reporters later in the week that a rate cut would be “warranted.”
The basis for the case for austerity now that inflation is more under control is the labor market, which Powell said this week is strong but not “overheated.”
With the unemployment rate rising above 4 percent and wage growth slowing, not only is the labor market no longer contributing to price pressures, but without careful policy coordination, post-pandemic gains could be at risk.
Avoiding that outcome was “the number one thing that keeps me up at night,” Powell told members of the House Financial Services Committee.
“I would say it sends a pretty big communication signal that you’re hearing so many of us and particularly Chairman Powell talking about how important the labor market is,” Daly told reporters.
That emphasis was also made by Lisa Cook, a Fed governor, in a speech this week, in which she said the Fed is “very alert” to changes in the unemployment rate and will be “responsive.”
The Fed is trying to engineer a “soft landing,” where inflation returns to its target without causing a sharp increase in layoffs.
That outcome depends on the Fed easing monetary policy soon and eventually cutting the policy rate to closer to 3 percent, said Priya Misra of JPMorgan Asset Management.
“The economy is really slowing down and it really looks like the labor market is slowing down as a result,” added Jonathan Pingle, a former Fed employee who is now chief economist at UBS.
“At some point they want the slowdown to stop and stabilize, but the risk is high. [that] it just goes on and on.”