– Monetary Policy Still Restrictive; To Make Meeting-by-Meeting Judgment on Risks
– Employment Risks Up; Inflation Pressure Lessening; Tariffs Not As Bad As Feared
– Other Fed Officials More Hesitant To Cut Funds Rate Furthermore
By Steven K. Beckner
(MaceNews) – After cutting interest rates mid-month to guard against “undue” weakness in the labor market in the face of lessening inflation pressures, the Federal Reserve still has monetary policy in a “restrictive” stance and will need to analyze incoming data to make “meeting by meeting” judgments on how much further to cut rates, New York Fed President John Williams said Monday afternoon.
Substantial divisions among Fed policymakers continue to be evident, however. .
Last week, several Fed officials vocally supported further easing, and Chairman Jerome Powell cautiously left the door open, but as this week began, the mood on additional rate cuts among some officials has been lukewarm at best, despite relatively mild inflation data and ongoing evidence of softening of the labor market.
While some officials have made clear they are willing to support additional rate cuts to counter “downside risks” to employment, others are more hesitant, putting greater emphasis on “upside risks” to inflation.
Williams, one of Powell’s top lieutenants, gave no clear signal as to when or by how much the Fed’s rate-setting Federal Open Market Committee,it might cut the key federal funds rate again, saying the FOMC must perform a “balancing act” between risks to inflation and employment.
By seemingly putting greater emphasis on unemployment, by downplaying inflation risks and by describing monetary policy as still “restrictive,” the FOMC Vice Chairman seemed to lean toward additional easing. But he did not clearlyk signal another rate cut is coming when the FOMC meets again Oct. 28-29.
About the same time, St. Louis Federal Reserve Bank President Alberto Musalem was calling it “appropriate” for the Fed to maintain a restrictive stance and said he could see only “limited room” for further rate cuts.
Cleveland Federal Reserve Bank President Beth Hammack also lived up to her reputation as one of the most hawkish Fed policymakers earlier Monday by saying the Fed should maintain a “restrictive” monetary stance, despite labor market “fragility.”
The comments follow Friday’s relatively mild inflation report from the Commerce Department. Its price index for personal consumption expenditures, the Fed’s favorite inflation gauge, rose 0.3% in August, up a tenth from July, leaving the PCE up 2.7% from a year earlier – a tenth more than in July. The more closely watched core PCE showed no acceleration, rising 0.2% in August and 2.9% from a year earlier – same as in July.
Despite persisting above-target inflation, the FOMC focused on labor market softening as it reduced the federal funds rate by 25 basis points on Sept. 17, taking its policy rate down to a target range of 4.0% to 4.25%.
What’s more, FOMC participants projected another 50 basis points of monetary easing will be done at the Committee’s remaining two meetings of 2025 – 25 basis points more than projected in June.
The action followed months of strident demands from President Trump for a looser monetary policy.
Powell explained the much anticipated move in his post-FOMC press conference: “With downside risks to employment having increased, the balance of risks has shifted.” He said tariff hikes have put upward pressure on prices, but said “a reasonable base case is that the effects on inflation will be relatively short-lived—a one-time shift in the price level.”
But the outcome of the FOMC’s late October meeting seems in doubt, given what Powell called the “wide dispersion of views” on the Committee.
Only one member dissented when the FOMC voted to cut the funds rate after leaving it unchanged all year, and that one dissenter (recent Trump appointee Gov. Stephen Miran) had wanted a larger reduction. But since the meeting, deep divisions have been revealed as an array of officials made public remarks.
Last week, Miran argued that the funds rate should be slashed to “the mid-twos,” and Gov. Michelle Bowman urged the FOMC fo “act decisively and proactively to address decreasing labor market dynamism and emerging signs of fragility,” now that “upside risks to price stability have diminished.”
San Francisco Federal Reserve Bank President Mary Daly also sounded open to additional cuts to some degree, saying she “think(s) a little bit more will be needed over time to get that interest rate where it’s balancing out those two risks.”
But as this week began, some officials’ comments on additional rate cuts have been lukewarm at best, despite relatively mild inflation data and going evidence of softening of the labor market.
Williams allowed for additional rate cuts in a discussion at the Rochester Institute of Technology, but stopped well short of being an outspoken advocate in the Miran or Bowman mold.
In his very response to a student’s question, he asserted, “Monetary policy has been and continues to be restrictive,” and he added that “we’re still in a position that it’s putting downward pressure on inflation.”
Williams proceeded to observe that inflation has come down from over 7% to 2.7% (using the Fed’s preferred PCE price index), but said “we still have a ways to go to get to our 2% goal; that’s why we have had … interest rates higher than normal.”
But he added that the Fed wants to get inflation back down to 2% “while at the same time not doing undue harm to our other goal” of “maximum employment,” and he observed that risks have been increasing on that side of the Fed’s dual mandate.
“We have a balancing act here,” Williams said. “Inflation has been coming down, but then we have had relatively modest effects of tariffs….”
Meanwhile, “the labor market has been remarkably resilient,” he went on, but “it is gradually softening The unemployment rate has picked up. There are signs the labor market is softening. We don’t want to see that go too far.”
When the Fed’s goals are “moving away from desired levels,” the FOMC must do a “balancing act,” he repeated, adding that he and his fellow Fed policymakers face a situation in which “risks to our employment goal, the unemployment rate, are getting a little higher; at the same time upside risks to inflation have come down” because “the tariff effects are smaller than we thought.’
Williams estimated that, excluding the impact of tariffs on imported goods, underlying inflation is about 2.4%, and he said there are few signs of inflation risks building.
Given that “the risks have nudged closer together,” he said the FOMC decided to “move rates down a little bit … to reduce risk” to employment.
As for what the FOMC will do next, Williams was purposefully vague.
“We need to be driven by the data and see how the economy is likely to evolve,” he replied. In particular, he said the FOMC will need to ascertain “what are the risks” to the labor market and whether “the unemployment rate (is headed) higher or lower.”
Williams said the FOMC “will try to keep a balancing act between keeping employment in a good place and keeping inflation moving lower.”
“We will make the best judgment we can meeting by meeting as we get more data,” he added.
Other Fed officials who spoke Monday were much more skittish about continuing to reduce rates, given still “elevated” inflation.
Musalem voted for the 25 basis point rate cut on Sept. 17, but foresaw only “limited room for easing further without policy becoming overly accommodative” in remarks at the St. Louis Fed.
Musalem didn’t rule out additional rate cuts if the labor market continues to soften provided inflation and inflation expectations were trending in the right direction, but said the FOMC must tread carefully.
Hammack, who earned her “hawkish” credentials by dissenting against rate cuts last fall, left little doubt she will oppose further rate cuts this year at a European Central Bank Conference on Inflation early Monday.
Acknowledging “signs of fragility in the labor market,” but noting that inflation remains too high, she said, “Right now when I look at that balance of risks I think we need to maintain a restrictive stance of policy so we can bring inflation back to target.”
Hammack, who was on a panel with other central bankers, said she and her Fed colleagues are confronted with difficult questions about the impact of tariffs, inflation expectations, and the true “neutral” level of the funds rate.
She said the question for the Fed is: “are tariffs going to be a one-time price level impact or are they going to be more persistent?”
So far, the impact of tariffs has “definitely been less than I would have anticipated when the tariffs were first announced,” Hammack said, but she suggested this sanguine situation may not last, based on what companies are telling her.
“It’s not that exporters are picking up most of it, although there are some cases where you see exporters are picking up some of it,” she said.
“Businesses pulled ahead their inventory accumulation pretty significantly in the first quarter…and what we’ve seen is that businesses are slowly working through that inventory to get that out,” she continued. “It feels to me now from my conversations with businesses that they are largely through that inventory pull-ahead and that there may be a second round of impacts that we see coming through.”
Hammack said she’s also hearing that “businesses have been trying to buffer consumers. They’re worried because we’ve been in this environment of above-target inflation for quite some time. They recognize that in the U.S. we’ve got this two-speed economy going, where the top end of the wealth spectrum is doing incredibly well and (can handle) price increases, but the lower and middle income families are really struggling and most of their paycheck is going to housing and food and gasoline prices, and they don’t really have a lot of disposable income to spend.”
“So we have seen businesses more cautious about passing on some of those costs, and they’ve been trying to absorb some of it,” she continued. “From my discussions with businesses, that’s not going to last forever. They’re going to have to start pushing that forward. That’s another place we could see it coming through.”
“My guess is that the longer tariffs are in place, the more that bleeds in. and so you could see again more of these impacts flow into it,” she went on.
Referring to the debate over whether the impact of tariffs on inflation is “transitory or more persistent,” Hammack observed, “If it’s transitory, but it takes two years for the full impact to come through is that transitory? How do you think about that in terms of what that’s going to do to individuals’ and businesses’ inflation expectations and their experience and how that flows through to the growth outlook?”
Hammack also stressed the importance of inflation expectations, saying she monitors both market-based and survey measures.
“Do markets believe are we serious about our 2% inflation objective?” she asked. “If I see that drifting away, that says to me that markets might be interpreting us as being less serious than I am, or that we intend to be about getting back to the 2% inflation target. And that’s an important signal for me, just in terms of our ability to deliver against the mandate.”
Under its recently revised monetary policy “framework,” the FOMC intends to take a “balanced approach” when its “price stability” and “maximum employment” mandates are “not complementary” — “taking into account the extent of departures from its goals and the potentially different time horizons over which employment and inflation are projected to return to levels judged consistent with its mandate.”
With labor markets now softening and the unemployment rate rising while inflation remains above target, Powell said last week that the FOMC is in a “challenging situation” because its two goals are “in tension.”
But Hammack questioned how much weight the FOMC should put on employment, when the unemployment remains a relatively low 4.2% and inflation is running close to 3%. Sha argued the Fed has a bigger “miss” of its explicit inflation target than it has on its implicit employment goal.
“How should we think about the miss?” she asked. “When I look at the miss on the employment side and that persistence, just take a look at the SEP, you’re looking at a couple or a few tenths of a miss on the unemployment rate to persist for one to two years kind of time frame, versus, if you look forward at the miss on the inflation side, that looks like it’s going to be a much bigger number for a longer period of time.”
Hammack also indicated she strongly disagrees with contentions, particularly by Miran, that the real equilibrium short-term interest rate or “r*” has fallen and that this in turn has lowered the “neutral” funds rate.
The level of r* (the real rate) matters because it “helps you understand how much distance you need to travel,” she said, and “right now there is meaningful disagreement – you can see in the dot plot, there’s about 200 basis points of range between r* estimates in the U.S.”
Before the Great Financial Crisis, she recalled, the nominal funds rate varied from 3% to 6%, and it was generally thought that r* was about 2%, but after the crisis r* estimates fell to a half percent or less, and the FOMC slashed the nominal funds rate near zero, while also greatly expanding its balance sheet.
But “now that we’re coming out of the pandemic, is there something different?” Hammack asked. “Are we going back to that pre-GFC experience and getting back to that similar inflation experience, productivity experience, whatever things are driving it? Or are we going to continue to be in that kind of 2008-20 type range of this very low r*?”
“How do we know that?” she continued. Some say “we know it by its works, but how do you see … where’s the evidence you can draw on that, and how do you bring that theory and practice together to get good insight into where policy actually is?
Governor Christopher Waller, who is said to be under consideration by President Trump to succeed Powell when his term as chairman expires next May and who has been more zealous than most in pushing for lower rates, also spoke Monday morning, but his prepared remarks were confined to central bank payment systems.
Last week, other Fed officials also exhibited a reluctance to cut rates, contradicting Miran, Bowman and others.
Kansas City Fed chief Jeffrey Schmid, voted for the recent cut, but seemed to withhold support for additional cuts. He said he viewed the modest Sept. 17 rate cuts “as a reasonable risk-management strategy as the Fed balances its inflation objective with some heightened concern over the health of the labor market.” But he added, “I view the current stance of policy as only slightly restrictive, which I think is the right place to be.”
Another voter, Chicago Fed President Austan Goolsbee, pronounced himself “somewhat uneasy with front-loading too many rate cuts based just on the payroll jobs numbers slowing down. If we are in this environment where inflation’s been above the 2% target for almost five years in a row now, and it’s going the wrong way, just counting on the inflation to be transitory makes me uneasy.”
Powell seemed noncommital last week, saying the FOMC faces “a challenging situation” of risks on both sides of its dual mandate and adding, “Two-sided risks mean that there is no risk-free path.”
“If we ease too aggressively, we could leave the inflation job unfinished and need to reverse course later to fully restore 2% inflation,” he continued. “If we maintain restrictive policy too long, the labor market could soften unnecessarily. When our goals are in tension like this, our framework calls for us to balance both sides of our dual mandate.”
Powell said it was “appropriate at our last meeting to take another step toward a more neutral policy stance,” because of “the increased downside risks to employment,” but he sounded ambivalent about further moves away from a “still modestly restrictive” stance. He reiterated that
“our policy is not on a preset course” and that the FOMC will “determine the appropriate stance based on the incoming data, the evolving outlook, and the balance of risks.”