U.S. Federal Reserve Chairman Jerome Powell leaves after holding a press conference in Washington, D.C., on Sept. 18. The U.S. Federal Reserve cut its key lending rate by half a percentage-point Wednesday in its first reduction since the pandemic, sharply lowering borrowing costs shortly before November's presidential election.MANDEL NGAN/AFP/Getty Images
John Rapley is an author and academic who divides his time among London, Johannesburg and Ottawa. His books include Why Empires Fall (Yale University Press, 2023) and Twilight of the Money Gods (Simon and Schuster, 2017).
Jerome Powell and his colleagues at the U.S. Federal Reserve placed their bets this week with an oversized half-point cut to interest rates. Amid considerable uncertainty about the direction of the economy, they put their faith in a Goldilocks scenario of continued growth but tame inflation.
If the governors at the Fed got it right, if inflation keeps falling and the economy skirts a recession, Mr. Powell will go down in popular lore as one of the greatest Fed chairs ever for having engineered that rarest of outcomes, a soft landing. But if they got it wrong, and inflation turns back up in the coming months, he’ll be remembered as the failure who was easily bullied into doing investors’ bidding.
That’s because while everyone knew the U.S. Federal Reserve would be cutting interest rates this week, nobody knew by how much it would do so, and most assumed the cut would be only a quarter point. However, after reports came out in the business press last weekend about market anticipation that the Fed would cut by more than expected, traders ramped up their bets on a half-point cut to interest rates.
Lo and behold, on Wednesday the Fed announced a half-point cut. Investors were delighted. In the minutes that followed the announcement, prices on everything in the asset markets, from stocks and gold to crypto, shot up in celebration.
The Fed’s stated position is that inflation is under control and it now wants to ensure the economy doesn’t slide into recession. Yet while the economy is clearly slowing and inflation has come down, it’s still not clear either that inflation is definitively beaten or that a recession is imminent. Unlike in Canada, where the indicators make the course ahead clearer for the Bank of Canada’s rate-cutting path, the data in the United States remain far more mixed.
Instead, the U.S. economy looks like it’s sitting on a fence and, as is the case with the U.S. election, it’s a coin-toss on which side it will fall. Industrial production is declining, but retail sales remain strong. Job-creation has slowed a lot, yet unemployment remains low and real wages keep rising. As for any signs of an imminent recession, in the update of its economic forecast this week, the Atlanta Fed predicted a GDP growth rate this quarter of 3 per cent, which is hardly indicative of an economy on the brink.
Like the economic data, the inflation data are equally ambiguous. Inflation is getting close to the Fed’s 2-per-cent target, but it isn’t there yet, and its pace of reduction is slowing much more than has been the case in Canada. The core rate remains particularly sticky. Amid already-accommodative monetary conditions, the Fed now runs the risk that further loosening will cause inflation to bounce back up. For their part, fund managers assume profits will continue to be strong, with a recent Bank of America survey finding that only 11 per cent of them believe the U.S. is headed into recession.
So the Fed had to make a judgment call and fall on one side of the fence or the other. On the face of it, a half-point cut suggested it judged the risks to the economy greater than those to inflation. Yet in his remarks at the news conference that followed the meeting, Mr. Powell insisted the labour market was looking pretty healthy and the economy was “in a good place.” Which raised the question of why they cut so aggressively. After all, other central banks are moving with caution: On Thursday, the Bank of England, faced with sticky inflation, held off further rate cuts while the Bank of Japan is now raising them.
For now, with U.S. asset classes in full-on rally mode, investors seem to have concluded that the Fed is back on their side and sees its role as keeping them happy. Despite the governors indicating they don’t intend to return rates to the low levels of the past, futures markets are still anticipating interest rates will fall faster and further than the dot-plot of expected cuts issued by the governors would suggest.
There is, however, one corner of the market that isn’t quite sharing in the euphoria, and it may be ominous: bond markets. By the end of Wednesday, yields on long bonds had begun rising, which suggests investors are either taking the Fed at its word that rates won’t fall very far, or worse, are worried the Fed fell on the wrong side of the fence and inflation will now go back up.
The data releases in the coming months will reveal whether the American central bank got this right. But if markets have concluded that the Powell put – the implicit guarantee that if asset prices fall, the Fed will print more money to juice them – is back and the central bank will abandon its inflation fight to keep investors happy, Mr. Powell’s job just got harder.