Risk balance changes! The Fed must address this issue this week

This week, Federal Reserve officials will deliver speeches at the annual central bank conference held in Jackson Hole, Wyoming. They can take some comfort in the fact that the current U.S. unemployment rate is 4.3%, still historically low by standards.

However, the usual scenario is this: since the late 1940s, the U.S. unemployment rate has often been below the long-term average of 5.7%, until it rapidly rises well above this level. Federal Reserve officials are concerned that this phenomenon may occur again, and the current trend is still unclear.

From 3.7% in January 2023 to 4.3% in July 2024, the steady rise in the unemployment rate is accompanied by an increase of 1.2 million job seekers, which is typically seen as a positive signal for the economy but could also lead to an increase in unemployment.

However, recently, Federal Reserve officials have more explicitly stated that the softness in the potential job market has led them to prepare for a rate cut after keeping the Fed's benchmark policy rate in the range of 5.25%-5.50% for over a year. The current rate level is the highest in 25 years.

Minneapolis Fed President Kashkari recently told the Wall Street Journal, "The risk balance has shifted, so the discussion about a rate cut in September is a discussion that should take place."

Other Fed officials, including San Francisco Fed President Daly, have indicated in other interviews that they are increasingly confident that inflation is returning to the Fed's 2% target, and they are willing to cut rates.

It is expected that the Fed will cut rates by 25 basis points next month. In addition, policymakers will provide a new forecast showing their views on how rates and the economy will evolve for the remainder of this year and in 2025.

Fed Chair Powell will speak at the Jackson Hole conference on Friday, further solidifying the view that the Fed will begin gradually easing after taming the most severe inflation outbreak in 40 years.

Fed policymakers hope to cut rates promptly and accurately, achieving a textbook "soft landing," where inflation slows down without a significant rise in unemployment.

A significant rise in unemployment is usually accompanied by central bank efforts to restrict economic activity by raising rates to curb the pace of price increases. In past monetary tightening cycles, once the unemployment rate starts to rise, it continues to rise.

In contrast, the progress made in inflation by the Fed in this cycle has been significant. The PCE price index favored by the Fed saw a year-on-year growth rate of 7.1% in June 2022, which has now dropped to 2.5% as of July, moving towards the Fed's 2% target.

However, until recently, the unemployment rate has hardly changed, remaining below 4% for two consecutive years, with wage growth far exceeding the average level of the past decade before the COVID-19 pandemic.

This year, this trend is starting to change, and Fed officials are increasingly focusing on the risks they see due to monetary policy being too tight for too long, with recent labor market data showing why they are concerned A U.S. government report stated that job growth in July was weaker than expected, with employers adding only 114,000 positions. The data for July brought the three-month average below pre-pandemic trends and raised the unemployment rate by 0.2 percentage points to 4.3%.

Furthermore, some aspects of the data in terms of monthly changes, such as people entering and leaving the workforce or job hunting, are not encouraging. While the overall labor force is increasing, which is a positive change, it seems to be taking longer for people to find jobs, reflected in the increase in the number of people entering the labor force who first experience a period of unemployment before being able to find work.

Additionally, federal labor mobility data shows that the number of people transitioning from employment to unemployment each month is increasing. However, at the same time, there has not been a significant increase in unemployment benefit claimants, actually remaining consistent with labor force growth.

With consumer spending remaining strong and economic growth potentially slowing but still positive, the Federal Reserve is not yet ready to view the job market as a crisis—it simply wants to avoid creating one.

Daly stated last Sunday that maintaining high rates while inflation is declining "will lead to the undesirable outcome of price stability but an unstable and faltering job market."

Chicago Fed President Evans also expressed a similar view last Sunday, "If you tighten too much, you will have problems on the employment side of the Fed's mandate."