Powell won't let the market determine rate cuts

University of California, Berkeley's economics professor Barry Eichengreen recently wrote that the stock market trend is not a reliable signal of an impending economic recession. Here are his views.

Global stock markets are in turmoil, with last Friday's disappointing US jobs report causing market shock. Whenever such fluctuations occur in the market, there are always speculations about the Federal Reserve cutting interest rates.

The Federal Open Market Committee (FOMC) has several options in front of them. They may urgently cut rates before the September meeting, similar to their response to the COVID-19 pandemic in March 2020. Or they could wait until September but cut rates by more than the previously implied 25 basis points. However, the most likely scenario is that the Federal Reserve will ignore the market volatility.

First and foremost, it is important to remember that, as the Federal Reserve surely knows, the stock market does not represent the entire economy.

The Federal Reserve focuses on inflation and economic growth, not stock price levels or their volatility. It only reacts when stock market fluctuations threaten financial stability. Currently, there is no indication that this situation is occurring.

Similarly, there is no sign that an economic recession is imminent. As Nobel laureate Paul Samuelson's famous quote points out, "In the past five economic recessions, the stock market predicted nine of them," the stock market is not a reliable signal of an economic recession.

Furthermore, a bad jobs report is not enough to form a trend. Until June, employment data was still strong. Despite a two-percentage-point increase in the unemployment rate in July, 114,000 new jobs were still added. More workers entering the labor market is not a bad thing.

Most importantly, employment data is "noisy."

The July data was affected by the disruption caused by Hurricane Beryl. These data may also undergo significant revisions after more information is obtained. The Federal Reserve may have to wait for these revised data before drawing definitive conclusions.

While last Friday's jobs report may have triggered a market reaction, other factors have also heightened investor anxiety.

The bubble in the artificial intelligence sector is deflating, with investors questioning whether there will truly be an explosive growth in productivity. Earlier this week, tech stocks like NVIDIA and Samsung leading the market downturn was no coincidence. Additionally, the crises in Gaza and the West Bank remain unresolved, and a potential war between Israel and Iran could drag other countries into it.

Some may argue that the market's disappointment in AI returns and concerns about the Middle East situation are reasons for expecting a slowdown in consumer spending and a possible economic recession in the United States, giving the Federal Reserve additional impetus to cut rates.

But it must be emphasized again that FOMC members are likely to take a wait-and-see approach. They understand that emergency rate cuts between meetings, or even a larger-than-expected 50 basis point cut in September, are more likely to cause market panic than stability.

Finally, Federal Reserve Chairman Powell and others are aware that the United States is in the midst of a presidential election. While Trump claims to be a supporter of low interest rates, he will certainly complain that any action taken by the Federal Reserve to stimulate the economy is an attempt to favor Harris and the Democratic Party in the election.**

Trump understands that the ruling party is usually seen as the controller of the economy. From now until November, if the economy and market performance are poor, this will be advantageous for the Republican Party.

The Federal Reserve does not care about politics, it will not succumb to political pressure, and Powell has repeatedly emphasized this. However, the premise of maintaining the central bank's independence is to remain politically neutral. In order to maintain this independence, the Federal Reserve must avoid excessive focus on and criticism of politics, which is necessary both now and in the future.

This means that the Federal Reserve may proceed cautiously and gradually. Its guidance has led the market to expect a 25 basis point rate cut in September, with several more cuts possibly following, but likely not until after the election. It is unlikely to disappoint on this issue.

Historians may conclude that the Federal Reserve under Powell's leadership cut rates too slowly in the face of a weak economy in 2024, just as it reacted too slowly to rising inflation at the end of 2021.

Time and future data will provide us with the answers. The only thing that is certain is that when Powell attends the Jackson Hole Symposium in two weeks, he will have a lot of explaining to do