IS THE US FED READY TO CUT RATES IN SEPTEMBER MEET?
Between now and the September Fed meet, there are several data points to contend with. There will be the consumer inflation for July and August and the PCE inflation for July. More importantly, there will be the Jackson Hole symposium between August 22nds and August 24ths, coming up later this month. The Jackson Hole Symposium is a select gathering of leading central bankers in the world, especially the key central banks like the ECB, BOE and the Bank of Japan. Apart from the central bankers, leading academicians and policymakers are also invited to the symposium. The significance of the Jacson Hole Symposium is that it offers a platform to debate on the outlook for monetary policy and ways and means to ensure that central bank monetary policy is convergent.
Quite often, the bigger picture becomes evident at the Jackson Hole Symposium wherein the differences in the approach to monetary policy come out quite clearly. The idea of synchronizing monetary policy is to reduce the shocks in the global financial markets. A classic example is the decision of the Bank of Japan to turn hawkish at a time when the world was shifting towards a more dovish tone. The sudden divergence led to the abrupt unwinding of yen carry trades, creating tumult in global financial markets in a big away. The outcome of the talks at the Jackson Hole symposium will have a critical bearing on how the Fed conducts its monetary policy. However, one indication that is coming out is that the Fed may not rush into a rate cut in September and would be a lot more cautious. That was revealed in a recent speech delivered by Michelle Bowman.
HOW MICHELLE BOWMAN SEES THE MONETARY POLICY OUTLOOK
Speaking at the Senior Management Summit at the Kansas Bankers Association; Fed governor Michelle Bowman underlined that while inflation had been tapering, the Fed may have to ideally wait till the end of the year for its first rate cut. This is in stark contrast to the general view of the CME Fedwatch that the Fed may take up 3 rate cuts in 2024 itself and add another 5 rate cuts in 2025. That may be too aggressive, as per Michelle Bowman. Here is what Michelle Bowman underlined in her recent speech.
- Bowman underscored the fact that the Fed had substantially tightened the stance of monetary policy since the start of 2022 to rein in high inflation. In the July 31, 2024 meeting of the Fed, the Fed chair Jerome Powell had finally given a hint of a likely rate cut in September 2024, subject to data being supportive.
- According to Bowman, while rate cuts would eventually happen, the pace may not be as aggressive as the markets would want to believe. As Bowman underlined, the fall in inflation was much sharper in late 2022 and early 2023, but since then the pace of falling inflation had also slackened. Also, the Fed had not hiked rates since July 2023, hoping that the lag effect would take care of inflation.
- The challenge, according to Bowman, is that even after the sharpest pace of rate hikes, the PCE inflation continues to be 60-80 bps above the Fed target of 2% and looked vulnerable to bounce if oil prices were to rally. Bowman acknowledged that the progress in lowering inflation during May and June was a welcome development, but the Fed would ideally like to see more traction before cutting rates.
- Bowman has pointed out that the average PCE inflation over the rolling 6 months was more smoothening compared to latest month numbers. By that definition, core PCE inflation (devoid of food and fuel) averaged 3.4% per annum in the first half of 2024. Much of the inflation relief in the last year and half came from the supply constraints normalizing. However, that is almost entirely done and dusted and the markets must not expect any more relief from that front. If anything, the core inflation may only bounce higher from the current levels.
- According to Bowman, the Fed not only looks at actual inflation but also at inflation expectations. The only reason the inflation expectations have been under control is the willingness of the Fed to intervene and raise rates to curb inflation. Typically, high prices tend to hit the lower income and more vulnerable sections a lot harder, which is why the Fed is unlikely to take any chances with inflation expectations. Also, while goods inflation has been consistently tapering, the pressure is coming from services inflation.
In short, inflation is coming down, but not to the extent and not with the conviction that the Fed would have anticipated. The last mile was proving much harder than imagined. Let us now turn to 3 other supportive factors that go into the rate cut decision.
GDP GROWTH, CONSUMPTION, LABOUR – THE TROIKA EFFECT
When the Fed takes the rate cut decision or otherwise, the primary consideration is the inflation. However, that is not the only factor. The Fed also tries to find out if the other macros are supportive. For instance, if inflation is falling but wages are still too high, then the inflation was bound to bounce back to higher levels. Similarly, growth and consumption continued to be robust, then low inflation would be tough to sustain. Here is what Michelle Bowman thinks about these 3 key variables.
- Let us start with the GDP growth or the economy activity in the US in the first half of 2024. The good news, according to Michelle Bowman, was that the economic activity had moderated in the first half of 2024 after showing a lot of back-ended resilience in the second half of 2023. For instance, GDP growth had come in at 4.9% in Q3 and 3.4% in Q4 of 2023. That is the kind of economic robustness that cannot support low levels of consumer inflation. During the first half of 2024, the GDP growth was much slower. In fact, it went as low as 1.4% in the first quarter, although the second quarter first advance estimate has seen a bounce in GDP growth to 2.8%.
- The second important factor is the consumer spending. The news is mixed on this front. In the second quarter to June 2024, the consumer spending strengthened. However, consumers are pulling back on discretionary items and expenses, as evidenced in part by a decline in restaurant spending since late last year. The bigger urgency is that the low- and moderate-income consumers do not have too much of savings to support this type of spending, and that has led to a normalization of loan delinquency rates.
- The labour market continues to loosen, as the number of available workers has increased and the number of available jobs has declined. The July data even hinted at a genuine slowdown in the US economy based on the sharp spike in unemployment and the fall in wage levels. In fact, the July employment report showed that unemployment rate stood at 4.3% and has risen by nearly 100 bps in the last one year. It is now a good 80 bps above the rate that is described as full employment in the US markets. More importantly, there is slowing in wage growth, which stands at under 4%.
With the inflation showing falling traction and the data on economic activity, labour and consumer spending also turning supportive, will the Fed go for a rate cut in September?
DOES MICHELLE BOWMAN SEE A RATE CUT IN SEPTEMBER 2024?
Michelle Bowman has been one of the hardest hawks of the FOMC. However, now, even Bowman feels that the baseline outlook for inflation may be changing to a more dovish note. However, the incoming data should consistently point to inflation moving sustainably toward the 2% goal. Having said that, Bowman suggests it would be better to be patient and data driven, rather than give into time bound targets for rate cuts. Here is why Bowman still remains cautious despite the positive triggers from the key data points.
- One of the important points made by Bowman is that substantial part of the inflation control progress in the last one year was on account of supply-side improvements. The supply chain constraints created by the pandemic were easing and that was the big thrust areas for the US economy. According to Bowman, it was unlikely that further improvements along this margin will continue to lower inflation going forward, as supply chains have largely normalized at a global level and the flow of raw materials and finished is fairly smooth now.
- According to Michelle Bowman, one cannot ignore the upside risks to inflation emanating from the geopolitical risks. Today, there are geopolitical risks in Middle East, West Asia, Europe, and Tiawan. With the recent surge in container shipping costs originating in Asia, the global supply chain remains susceptible to disruptions. This is likely to put immense pressure on food, energy and commodity prices. In addition, it could also result in imported inflation.
- Last, but not the least, Bowman believes that there is the lurking risk that the increased immigration could lead to persistently high housing services inflation. Given the current low inventory of affordable housing, the inflow of new immigrants to certain geographic areas could exert substantial upward pressure on rents. As housing supply takes time to materialize, the impact on inflation could be fairly deep.
So, how do all these data points and news flows highlighted by Michelle Bowman impact the rates trajectory of the US Fed?
HOW THE US FED IS LIKELY TO ACT ON RATES?
Bowman has underlined that there cannot be discrete answers to such a complex and multivariate problem. There could be a range of possible scenarios that could unfold when assessing how the FOMC’s monetary policy decisions may evolve; starting from September 2024. Fed has again underlined that it would be solely and largely be guided only by the incoming data flows. According to Bowman, even equity prices have been volatile of late, but are still higher than at the end of last year.
According to Bowman, inflation is still a little elevated and the upside risks to inflation also cannot be ignored. The Fed is likely to focus predominantly on the price stability aspect while taking its final decision on rates. Bowman feels that restoring price stability is the key to long term real growth in the US. And if that means rate cuts have to wait, then the rate cuts will have to actually wait till the end of 2024. In that case, September rate cut may be relatively optimistic.
