Federal Reserve Chairman Powell mentioned at the Jackson Hole meeting that with the emergence of risks in the job market, the Fed may cut interest rates. The upcoming non-farm payroll report will determine the extent of the rate cut to prevent further weakness in the labor market. Currently, the unemployment rate is 4.3%, higher than pre-pandemic levels, putting pressure on economic growth. The current Fed interest rate is 5.25%-5.50%, exceeding the target of 2.8% above the neutral rate
In 2022, the Federal Reserve will shift its focus to combating inflation and will have to quickly raise interest rates to align monetary policy with rapidly rising inflation.
Two years later, the focus of the Federal Reserve shifts once again, this time towards protecting the job market, as described by Federal Reserve Chairman Powell in his speech at the annual Jackson Hole meeting last Friday. It seems that monetary policy needs to catch up with the current situation again, although the pace may not be as fast, but the direction is different.
Powell hinted at an upcoming rate cut, completing the dovish shift that the Federal Reserve started in January of this year when they acknowledged new risks in the job market. Addressing these risks is now a top priority.
An unresolved question is: Is the soft job market and rising unemployment a sign of stable economic growth with low risk of rising unemployment, or is it the beginning of a slide? Will this slide accelerate?
The answer will be revealed in the upcoming non-farm payroll report, which will determine how much the Federal Reserve needs to cut rates to prevent what Powell described as "further unwelcome softening in labor market conditions."
"We are not seeking nor do we want further cooling in labor market conditions," Powell said, these remarks seem to indicate that he has set the current 4.3% unemployment rate in the U.S. as the level he wants to defend, as he acknowledged that "the current labor market conditions are not as tight as they were before the COVID-19 pandemic."
Is the U.S. economy on the edge of a cliff?
When Powell took office as Federal Reserve Chairman in 2018, the U.S. unemployment rate was 4.1% and falling, reaching a low of 3.5% in 2019 without sparking inflation concerns. Powell expressed his hope to recreate these conditions after the COVID-19 pandemic pushed the economy into a downward spiral.
Currently, the federal funds rate is at 5.25%-5.50%, which is seen as constraining economic growth and jeopardizing jobs, far above officials' median estimate of 2.8% for the long-term neutral rate. Assuming inflation continues to trend towards the Federal Reserve's 2% target, changes in the job market will determine how quickly officials move towards that neutral level and whether they need to further lower rates to restore full employment.
"The economy is indeed cooling, but are we cooling to a stable level... or is this just a brief pause before a more significant cooling?" said Nela Richardson, Chief Economist at ADP, during the meeting breaks.
Richardson, along with many Federal Reserve officials and attendees, believe that the economy remains strong and may just be returning to its underlying trend, normalizing from the extreme conditions brought about by the pandemic. However, the sense of urgency around employment has intensified.
The Federal Reserve's two-year battle with inflation has pushed rates to their highest point in 25 years without significant negative impacts on the job market. Officials will start the next meeting on September 17th to 18th with a markedly different stance from a few weeks ago, preparing to cut rates and discuss whether the job market is just slowing down or on the edge of a cliff The Fed's Risk-Related Language Has Been Gradually Changing This Year. In January, the Fed's policy statement stated that officials were "closely monitoring" inflation risks and noted that "the risks to achieving its employment and inflation goals are becoming more balanced."
In June, the Fed stated that risks "have become more balanced," in July it said risks "continue to become more balanced," and added that they are now "monitoring" the labor market and inflation.
Powell's speech completed this journey, stating that "the risk balance of the Fed's two goals has changed," and policymakers will "make every effort to support a strong labor market."
It's Time for the Fed to "Catch Up" Now
In September, officials will update their interest rate forecasts, showing their views on the pace of future rate cuts. Just in June, they were still concerned about sticky inflation, expecting the unemployment rate to stabilize at 4%, and projecting only one percentage point cut this year.
Ian Shepherdson, Chief Economist at Pantheon Macroeconomics, has been predicting a downturn in the labor market. He described Powell's tone relative to the outlook in June as "shocking," believing that this proves the Fed was worried about "waiting too long" to make a change.
Meanwhile, Torsten Slok, Chief Economist at Apollo Global Management, is concerned that if the Fed cuts rates too quickly due to the still low layoff rate, it may continue to trigger inflation risks.
Data shows that in July, the non-farm payroll in the U.S. was only 114,000, significantly weaker than the average level during the pandemic, but consistent with the reasonable speed previously considered to match population growth.
Another closely watched indicator, the ratio of job vacancies to unemployed persons, has dropped from a historical high of 2 to 1 during the pandemic to 1.2 to 1, equivalent to pre-pandemic levels, indicating that the economy is normalizing.
Powell even downplayed the 4.3% unemployment rate last Friday, attributing it to an increase in labor supply and a slowdown in hiring, rather than direct unemployment.
He said, "There is good reason to believe that the economy will return to a 2% inflation rate while maintaining a strong labor market."
Boston Fed President Collins, in an interview, expressed that she feels the labor market has "overall resilience" and the unemployment rate may be on the verge of stabilizing.
"What I see are signs of stabilization," she said, "rather than 'breakthroughs'."
However, concerns linger that the labor market may be softer than it appears on the surface, and these risks may manifest in the coming months, forcing the Fed to accelerate or increase the rate of rate cuts to defend its "maximum employment" goal.
Fed Governor Kugler is a professional labor economist, and she mentioned in a meeting discussion that both sides of the job vacancy-to-unemployed ratio may be misread—the number of job vacancies reported in the monthly Job Openings and Labor Turnover Survey is actually lower, and if other unemployment measures, including discouraged workers, are taken into account, the number of unemployed would be higher She estimates that the ratio of job openings to unemployed persons has actually dropped to 1.1, approaching equilibrium, or even lower. She said:
"If other unemployment indicators are also taken into account, the labor market may present a completely different picture."