‘The time has come’: The Fed just sent a crucial message about its next move

Washington (CNN) — America’s top central banker has unambiguously signaled that lower interest rates are finally on the horizon, marking a crucial milestone for the Federal Reserve’s historic — and, so far, successful — inflation fight.

“The time has come for policy to adjust,” Fed Chair Jerome Powell said in prepared remarks for his keynote speech at an annual gathering of central bankers and economists in Jackson Hole, Wyoming. “We will do everything we can to support a strong labor market as we make further progress toward price stability.”

The Fed chief also expressed confidence in the US economy’s ability to pull off a so-called soft landing, an extremely rare outcome in which inflation is tamed without a sharp rise in unemployment. Such an achievement has only happened once, in the mid-1990s.

“With an appropriate dialing back of policy restraint, there is good reason to think that the economy will get back to 2% inflation while maintaining a strong labor market,” he said.

Markets responded positively to Powell’s comments, with all three major indexes ending the day higher Friday.

“Powell has rung the bell for the start of the cutting cycle,” said Seema Shah, chief global strategist at Principal Asset Management, in a note Friday.

The Fed’s aggressive rate-hiking campaign, which started in early 2022, thrust interest rates up to a 23-year high in a bid to combat the highest inflation in decades. The Fed’s benchmark lending rate, which influences borrowing costs across the economy, has been perched at its current level for a year now. From mortgage rates to credit cards, everyday consumers and businesses have been squeezed by tough borrowing costs.

But the central bank’s aggressive action seems to be paying off. Inflation is down substantially from the 40-year highs of two years ago and while unemployment has crept up in recent months, the job market overall remains in good shape. And so does the broader US economy: Economic growth this year has been solid and the Atlanta Fed is projecting that growth hasn’t slipped. The Fed is indeed threading the needle for a soft landing.

Powell’s latest comments open the door wide open for the first interest rate cut since 2020, slated for the Fed’s upcoming policy meeting on September 17-18. Americans have already felt some relief thanks to tumbling bond yields, which move in anticipation of the Fed’s decisions on interest rates. Mortgage rates, which track the 10-year US Treasury yield, plummeted earlier this month.

“Things are going to hold up,” Tom Porcelli, chief US economist at PGIM Fixed Income, told CNN. “The labor market is cooling, but it’s not getting soft. Household balance sheets are solid overall, particularly on the higher end of the income spectrum who account for the bulk of aggregate spending.”

A major turning point

The Fed’s upcoming decision to cut interest rates is a sign that officials feel “confident” enough that price pressures are coming under control. A slowing job market is also playing a role in nudging the Fed to ease borrowing costs.

The Fed’s favorite inflation gauge — the Personal Consumption Expenditures price index — registered at an annual rate of 2.5% in June, down markedly from 7.1% just two years ago. Powell in his speech attributed that progress to the “unwinding” of pandemic-related distortions to supply and demand, which initially boosted inflation around the world in the aftermath of the Covid-19 pandemic.

Inflation plummeted in the second half of last year as the broader US economy remained robust. Much of that was thanks to improvements on the supply side, such as a bigger workforce and healing supply chains. The US economy also experienced a welcome burst of productivity growth, which strengthened growth without stoking inflation. The job market’s cooldown to a more normal state has also helped ease some upward pressure on prices.

“Our restrictive monetary policy contributed to a moderation in aggregate demand, which combined with improvements in aggregate supply to reduce inflationary pressures while allowing growth to continue at a healthy pace,” Powell said. “As labor demand also
moderated, the historically high level of vacancies relative to unemployment has normalized primarily through a decline in vacancies, without sizable and disruptive layoffs, bringing the labor market to a state where it is no longer a source of inflationary pressures.”

Job openings, a proxy for employer demand for workers, registered at 8.2 million in June, down markedly from the record high of 12.2 million in March 2022. Wage growth has also cooled substantially over the past few years.

The path ahead

The Fed has indeed seen some substantial progress in taming inflation, but a soft landing still isn’t guaranteed. The economy could hold up, or it could take a turn for the worse. Most economists aren’t expecting a recession this year, but economic forecasts sometimes don’t bear out.

Fed economists even noted during last month’s policy meeting that “the recent softening in some indicators of labor market conditions might be pointing to a larger-than-anticipated slowdown in aggregate demand growth,” according to minutes released earlier this week. Translation: The recent weakness in the job market could result in American shoppers curbing their spending more than expected.

A big question mark is the future of America’s job market, which is a key driver of the US economy. If Americans are having a hard time finding a new job — or worse, if they’re being laid off — then they’ll cut back their spending. That spells troubled ahead because consumer spending makes up about 70% of the US economy.

The Fed and Wall Street are paying close attention to the health of the US consumer. Major retailers such as Home Depot and Lowe’s have noted that American shoppers are spending more carefully nowadays, opting for cheaper alternatives. But it’s been a mixed bag: Walmart reported better-than-expected financials for its latest quarter. US sales at America’s largest retailer open for at least one year increased 4.2% last quarter and its operating income surged 8.5% during the quarter, as online sales grew 22%.

“There’s still a path for a soft landing, but that’s narrowing as the labor market slows, which is a source of spending,” said Elizabeth Renter, senior economist at NerdWallet.

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