Indiana Trust Wealth Management
Investment Advisory Services
by Clayton T. Bill, CFA
Vice President, Director of Investment Advisory Services
- The U.S. equity market, represented by the S&P 500 index, rose 1.5% for the week.
- Fed Chairman Jerome Powell’s speech in Jackson Hole on Friday was crystal clear: the time has come for interest rate cuts.
The BLS released its annual revision to its payroll data this week. Over the year through March, average monthly job gains were revised down to 174,000 from the originally estimated 242,000. While this large downward revision was expected by most economists, it does indicate a much less robust labor market than originally thought existed for the year.
Some economists think that the number of new jobs consistent with an inflation rate of 2% is lower than 174,000 each month, and that the economy is running at full employment, threatening a resurgence in demand-driven inflation. That camp considers the new, lower jobs figure as “too many” and believes the current 4.3% level of unemployment is fine.
However, as Jerome Powell pointed out on Friday in his Jackson Hole keynote address, when it comes to unemployment it is the direction of travel that matters, not the level. His language was crystal clear: given the “unmistakable” cooling in labor market conditions and rise in unemployment, “the time has come for policy to adjust”. Given the Fed’s current interest rate target rate of 5.5% and Mr. Powell’s confidence that inflation is trending to 2%, “adjust” means interest rate cuts at the Fed’s upcoming meetings.
The question now becomes the speed at which the Fed eases monetary policy. Philadelphia Fed President Patrick Harker opined on Thursday that “a slow, methodical approach down is the right way to go”, a view which was shared by others at the Fed. That approach translates to 0.25% reductions at subsequent meetings.
In its models, the Fed focuses upon the concept of a “neutral rate” of interest, at which inflation is mild and the economy is growing at a decent speed – not overheating or in recession. It is impossible to know what the neutral rate is because it is not observable. Also, there is a wide error band that exists around the neutral rate. All of that said, currently, the Fed believes that the neutral interest rate is 2.5%.
While 0.25% reductions at future meetings sounds like a prudent course of action, at that pace it would be December 2025 before the Fed reached its neutral interest rate target. Over that time, theoretically, the Fed’s policy would continue to be restrictive. Perhaps that is why in his comments, Mr. Powell noted that the Fed’s current policy rate “gives us ample room to respond” should the Fed need to accelerate rate cuts.
If the Fed wants to send a strong message that it does not want to see further cooling of the labor market from here, the Fed could defensibly kick off its rate cutting campaign with a 0.50% move in September.
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