– Timing of Rate Cuts Depends on How Favorable Inflation Data Look
– More Focused on Risks to Employment Side of Fed Dual Mandate
By Steven K. Beckner
(MaceNews) – Federal Reserve Governor Christopher Waller said Wednesday he believes the Fed is “getting closer” to cutting short-term interest rates, but said he still wants to see “more evidence” that disinflation will be sustained.
Not only has inflation moderated, but labor markets have softened and unemployment risks have risen, he said.
Waller, speaking at an event hosted by the Kansas City Federal Reserve Bank, said the timing of rate cuts will depend on which inflation scenario plays out. But he left no doubt he thinks rate cuts will be justified before long.
“(W)hile I don’t believe we have reached our final destination, I do believe we are getting closer to the time when a cut in the policy rate is warranted,” he said.
It was the latest signal that Fed policymakers are inching their way toward an eventual easing of monetary policy as they gradually become more convinced inflation is headed down toward their 2% target.
Fed Chair Jerome Powell, New York Federal Reserve Bank President John Williams and Fed Governor Adriana Kugler have also indicated in recent days an increasing willingness to cut rates at one or more of the Fed’s four remaining monetary policy meetings of 2024. But they have been careful to condition them on further progress in lowering inflation.
Waller largely echoed Powell, who seemed to hint again on Monday that the U.S. central bank is getting closer to having enough “confidence” that inflation is headed “sustainably” toward 2% to begin long-awaited reductions in the federal funds rate at one of its remaining four meetings of 2024.
As the week began, Powell seemed to go an incremental step further than he had last Tuesday and Wednesday when, in testimony on the Fed’s semi-annual Monetary Policy Report to Congress, he appeared to indicate a greater willingness to consider rate cuts by hinting at increased downside risks to the “maximum employment” side of the Fed’s dual mandate.
Powell said last week the Fed’s rate-setting Federal Open Market Committee needed “more good data” on inflation to “strengthen our confidence that inflation is moving sustainably toward 2%.” But he added, “At the same time, in light of the progress made both in lowering inflation and in cooling the labor market over the past two years, elevated inflation is not the only risk we face. Reducing policy restraint too late or too little could unduly weaken economic activity and employment.”
On Monday, Powell went a bit further. “We didn’t gain any additional confidence in the first quarter, but the three readings in the second quarter including the one from last week do add somewhat to confidence,” he told the Economic Club of Washington, D.C. “What increases that confidence is more good inflation data, and lately here we have been getting some of that.”
He repeated that the FOMC now needs to put more weight on the employment side of its mandate.
In the intervening days between his congressional testimony and his Economic Club remarks, the Labor Department released an encouraging June consumer price index report which seemed to confirm that disinflation had resumed following a first quarter upsurge in prices. The CPI fell 0.1% last month and was up just 3% from a year earlier – down from 3.3% in May. The core CPI was 3.3% higher.
Powell remained deliberately vague about when the first rate cut might come or whether the FOMC might ease more than once this year, saying, “We are going to make these decisions meeting by meeting and the evolving data and the balance of risks.”
Waller, who swung from musing about first half rate cuts last fall to taking a much more cautious position in recent months, now sounds far more willing to ease credit, though he remains somewhat cautious.
“(I)n the second quarter, data on inflation and the labor market moderated in a way that suggests progress toward price stability has resumed,” he said in prepared remarks.
“The data over the past couple months shows the economy growing at a more moderate pace, labor supply and demand apparently in balance, and inflation slowing from earlier this year,” he continued. “These are all developments that support progress toward achieving the FOMC’s dual-mandate goals.”
Waller said, “current data are consistent with achieving a soft landing, and I will be looking for data over the next couple months to buttress this view.”
“So, while I don’t believe we have reached our final destination, I do believe we are getting closer to the time when a cut in the policy rate is warranted,” he added.
Like many of his Fed colleagues, Waller focused on changes in the job market that have made them less concerned about overly tight labor market conditions and more concerned about potential increases in unemployment.
Although the unemployment rate has risen from 3.4% in January 2023 to 4.1% in June, Waller said the jobless rate is still historically low and said the labor market is in “a sweet spot” where employers have all the workers they need and are not inclined either to hire or fire.
“In terms of the employment leg of the dual mandate, we may well be able to achieve the soft landing,” he said.
However, Waller indicated he has begun to worry that the cooling of the labor market could go too far.
“(G)iven the normalization of the labor market, a continued decline in the job vacancy rate and the vacancy-to-unemployment ratio may lead to a larger increase in unemployment than we have seen the past two years,” he said. “In short, one implication of a balanced labor market is that the risk of it becoming too loose is more closely balanced with the risk of it being too tight.”
“This is a policy challenge that we have not faced for the past couple years,” he continued. “As of today, I see there is more upside risk to unemployment than we have seen for a long time.”
Meanwhile on the “price stability” side of the Fed’s dual mandate, inflation “data in recent months has been reassuring,” Waller said, adding that the June CPI report “was the second month of very good news.”
“So, after disappointing data to begin 2024, we now have a couple of months of data that I view as being more consistent with the steady progress we saw last year in reducing inflation, and also consistent with the FOMC’s price stability goal,” he said. “The evidence is mounting that the first quarter inflation data may have been an aberration and that the effects of tighter monetary policy have corralled high inflation.”
Waller said, “the recent data are making me more confident we will achieve the inflation goal of our dual mandate.”
However, Waller was not quite ready to conclude that the mix of favorable inflation and labor market data necessitate immediate rate action.
Speaking a couple of weeks ahead of the FOMC’s July 30-31 meeting, he said the Committee must weigh “two risks.”
“On the one hand, it is essential that monetary policy get inflation down to a sustained level of 2 percent,” he elaborated. “If we start to loosen policy too soon, and allow inflation to flare up again, we risk losing credibility with the public and allowing expectations of future inflation to become unanchored….”
“I need to see a bit more evidence that this will be sustained,” he added.
But Waller went on to warn that “the other risk is that we wait too long to ease monetary policy and contribute to a significant economic slowdown or a recession, with unemployment rising notably.”
He said he is making the “assumption…. that there is no significant deterioration in the labor market in the next several months—that we are able to keep the labor market in its current sweet spot.” But he said he “will be paying close attention to the employment side of our mandate.”
In one “optimistic” scenario, with continued “very favorable” inflation reports, he said he “would have much greater confidence in inflation moving sustainably toward 2%.” In that scenario, Waller said he “could envision a rate cut in the not-too-distant future,” but he foresaw “a significant but not high probability of this scenario occurring.”
Turning to a “more likely” second scenario, where “the inflation data comes in uneven,” Waller said, “it would be a matter of timing as to when I thought we are making sustainable progress to 2% inflation we need to make a rate cut.”
“In this case, a rate cut in the near future is more uncertain,” he added.
Waller also mentioned a dreaded third scenario, in which there could be “a significant resurgence in inflation in the second half of 2024.” Were that to happen, he said “it would be tough to conclude we were making sustainable progress on inflation this year.” But he said he considers that unlikely “given the recent data we have received.”
Nevertheless, Waller concluded that “the time to lower the policy rate is drawing closer.”
Responding to questions, Waller made clear rate cuts are probably coming before long, but declined to be pinned down on when the FOMC should start cutting the funds rate, although he seemed to rule out a late July move.
“From a macro perspective whether we go in September, November or Decembers really doesn’t matter,” he said, “Assuming no big shock to the economy from a macro perspective this really doesn’t matter very much.”
Waller acknowledged that the timing matters greatly to financial markets, but said for policymakers “it’s not our job to say whether one meeting or another… It’s not a particular meeting; it’s when conditions are right to go.”
He left no doubt about where rates are headed, saying, “the next direction for policy most likely is rate cuts at some point in the future.”
“We raised rates a lot to make policy restrictive and slow the economy down…,” he said. “Now that it‘s slowing, the discussion is of rate cuts in the future…”
“We don’t need rates to be as high,” he continued. “We can start to bring them back down to more normal levels.”
But as to when and how much to cut rat es, he said “there’s no point of me talking about that.”
Earlier, Williams also took a cautious step toward monetary easing in an interview published by the Wall Street Journal Wednesday.
Recent inflation data are “getting us closer to a disinflationary trend that we’re looking for,” the FOMC Vice Chairman said. “These are positive signs. I would like to see more data to gain further confidence inflation is moving sustainably to our 2% goal.”
Like Waller, Williams was reluctant to give timing signals, saying, “We’re actually going to learn a lot between July and September.”
And like Powell, he focused on risk management. “Both of our dual mandate goals are very much in the forefront of my thinking about policy decisions, but it is absolutely essential that we could achieve this goal of getting inflation back to 2%.”
But Williams suggested the balance of risks is tilting toward less concern about inflation, saying, “If we get more data like this, I think that I would find myself finding that greater confidence” that inflation is moving sustainably to 2%.
On Tuesday, Gov. Kugler also pointed in the direction of imminent easing, saying she is prepared to vote for rate cuts if recent inflation and labor market trends continue.
Kugler’s topic at a National Association for Business Economics Foundation seminar on Economic Measurement was “the challenges facing economic measurement and creative solutions.” But at tne end of her prepared remarks, she went out of her way to make comments on recent data and their monetary policy implications.
“Despite a few bumps at the beginning of the year, inflation has continued to trend down in all price categories…,” she said.
Kugler acknowledged that “inflation remains above our target,” but she anticipated that inflation will moderate further because “supply and demand are gradually coming into better balance.”
“Supply-side bottlenecks continue to heal, and demand has moderated amid high interest rates and as households’ excess savings have depleted,” she observed. “The labor market likewise has seen substantial rebalancing and nominal wage growth moderating as a result….”
Kugler said “this continued rebalancing suggests that inflation will continue to move down toward our 2 percent target….”
And she added, “if economic conditions continue to evolve in this favorable manner with more rapid disinflation, as evidenced in the inflation data of the past three months, and employment softening but remaining resilient as seen in the past few jobs reports, I anticipate that it will be appropriate to begin easing monetary policy later this year.”
Kugler said rate decisions “will continue to be data dependent,” but suggested the odds of rate cuts have increased by saying “upside risks to inflation and downside risks to employment have become much more balanced.”
The only question, according to Kugler, is how soon the FOMC pulls the trigger on rate cuts:
“If the labor market cools too much and unemployment continues to increase and is driven by layoffs, I would see it as appropriate to cut rates sooner rather than later. Alternatively, if incoming data do not provide confidence that inflation is moving sustainably toward 2%, it may be appropriate to hold rates steady for a little longer.”
Flat June retail sales were seen reinforcing the case for easing, and exuberant financial markets are now pricing in very high odds of an initial rate cut at the FOMC’s Sept. 17-18 meeting, despite the approaching Nov. 5 election.