Powell "pours cold water" on expectations of a significant rate cut, stating no rush for rapid rate cuts

Federal Reserve Chairman Powell said the Fed will "lower interest rates over time" while emphasizing that the overall U.S. economy still has a solid foundation.

Powell also reiterated his confidence that inflation will continue to move towards the Fed's 2% target, adding that the economic conditions have laid the foundation for further easing of price pressures.

"Looking ahead, if the economic outlook remains broadly consistent with expectations, policy will gradually shift to a more neutral stance," Powell said in a speech at the National Association for Business Economics annual meeting in Nashville. "But we are not on any preset course," he said, noting that policymakers will continue to make decisions based on upcoming economic data at each meeting.

Neutral policy refers to policies that neither stimulate nor hinder the economy. Despite the Fed lowering its benchmark interest rate to a range of 4.75%-5% earlier this month, it is still widely seen as restrictive to economic activity.

These remarks leave a lingering question about how policymakers will respond to the scale and pace of rate cuts in the coming months, which is crucial for investors.

During the Q&A session following the speech, Powell acknowledged that officials' forecasts released at the September rate decision indicated that the Fed would cut rates by 25 basis points at each of the next two meetings (November and December). However, he warned that the Federal Open Market Committee (FOMC) will make decisions to some extent based on information they have not yet received.

"The committee is not in a hurry to cut rates quickly. Ultimately, we will be guided by the data we receive. If the slowdown in the economy is greater than we expected, we can cut rates more quickly. If the pace is slower and the magnitude lower than we expected, we can slow down the pace.

The Fed lowered borrowing costs by 50 basis points at the beginning of September, its first rate cut since 2020, and took a larger-than-usual step. Officials made this significant rate cut to prevent further weakening in the slowing labor market.

Powell said on Monday that the labor market remains strong but noted that employment conditions "have cooled significantly over the past year." "We believe we do not need to see further cooling in labor market conditions to achieve a 2% inflation rate," he said.

Persistent Anti-Inflation

Inflation has been mild in recent months, and government data released last week reinforced this trend, with the Fed's preferred inflation gauge showing that the overall Personal Consumption Expenditures (PCE) price index rose by 2.2% year-on-year in August.

This has given officials more confidence that inflation is moving closer to their target, allowing them to focus more on supporting the labor market.

Powell said, "The foundation for anti-inflation is broad, and recent data suggests that the inflation rate is further progressing towards the sustained return to the 2% target."

Nevertheless, some policymakers remain cautious about cutting rates too quickly and are concerned that this may reignite inflationary pressures in the economy Powell said, "Our goal has always been to restore price stability while avoiding the rise in unemployment rates that often accompanies a cooling inflation. Although the task is not yet complete, we have made significant progress towards this outcome."

Powell acknowledged that the decline in housing inflation has been slow, but expressed confidence that it will further cool over time.

Non-Farm Payrolls Crucial

According to median forecasts, officials at an earlier meeting this month expected an additional 50 basis points rate cut for the remainder of 2024 and a further 100 basis points cut in 2025.

A few Fed officials have opened the door to this move, stating that any signs of significant weakness in the labor market could lead to another substantial rate cut.

Some officials also estimate that the degree of easing by the end of the year may be smaller. Fed Governor Bowman, who opposed a 50 basis points rate cut in September, supports a smaller rate cut. She emphasized that she believes inflation risks persist and that the Fed should lower rates at a "moderate" pace.

Following Powell's overnight speech, bond traders have lowered their expectations for rate cuts next year. Short-term interest rate futures traders now believe that the Fed is more likely to cut rates by 25 basis points in November, rather than 50 basis points.

On Tuesday, U.S. Treasuries gave back gains after a historic fifth consecutive month of increases. As measured by the Bloomberg US Treasury Total Return Index, the return on U.S. Treasuries was 1.4% as of last Friday, marking the longest monthly continuous increase in the market since 2010. Due to sticky inflation data weakening expectations of Fed rate cuts, yields have been falling since climbing in the first few months of the year, reversing losses from the beginning of the year to a gain of 4.1%.

Jack McIntyre, portfolio manager at Brandywine Global Investment Management, said, "The economic conditions are improving. Powell is placing more emphasis on the labor market, so the non-farm data on Friday will be more important. U.S. Treasuries have risen significantly, likely exceeding reality."

Priya Misra, portfolio manager at J.P. Morgan Asset Management, said, "We are at a critical turning point in data and policy. If new job additions exceed 150,000, market rate expectations may slightly rise as the likelihood of a 50 basis points rate cut in November decreases, while a figure close to 100,000 or lower could prompt the Fed to cut rates by 50 basis points again."

The latest labor market data will be released on Friday. Economists surveyed by Bloomberg expect employers to have added 150,000 jobs in September, in line with a slowing labor market. The unemployment rate, which has risen this year, is expected to stabilize at 4.2%