Economy

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“The balance of risks has shifted, so the debate about potentially cutting rates in September is an appropriate one to have,” Kashkari said in an interview with the WSJ.Kashkari’s remarks represent a shift from his stance in June, when he suggested that a rate cut might not be necessary until later in the year. The recent increase in the unemployment rate, which rose to 4.3% in July from 3.7% at the beginning of the year, has raised concerns about the potential for an undesirable economic slowdown.Kashkari noted that if the labor market hadn’t shown signs of weakening—if the unemployment rate had remained between 3.7% and 3.8%—he likely wouldn’t be considering whether to cut rates at this time. However, with progress on inflation and some troubling signs in the labor market, the conversation has changed.Despite this, the Fed Minneapolis president expressed caution about the size of potential rate cuts, stating that he sees no reason to lower rates by more than a quarter percentage point at a time, given that layoffs remain low and unemployment claims do not signal significant deterioration.“If we saw some quicker deterioration in the labor market, then that would tell me, ‘Well, we need to do more, quickly, to support the labor market, even if we have uncertainty about where our ultimate destination is going to be,” Kashkari told WSJ.Until inflation surged to a four-decade high in 2022, Kashkari was one of the Fed’s most dovish officials, prioritizing the labor market over inflation concerns. However, in recent years, he has become one of the more hawkish voices, showing greater concern about inflation risks.The Fed official remains unconvinced that the current rate levels are as restrictive as some have suggested. He pointed to the low number of layoffs and a resilient housing sector as indicators of this. Nevertheless, he acknowledged that this does not necessarily justify keeping rates unchanged.“I’m still unclear how tight policy is, but the balance of risks in my view have shifted more towards the labor market and away from the inflation side of our dual mandate,” said Kashkari. More

While recent inflation data has shown some cooling, the Fed is now more focused on labor market trends to guide its monetary policy decisions.Evercore ISI emphasized that the Federal Reserve has transitioned to being a “labor data-first Fed, not an inflation data-first Fed.” This means that the strength or weakness of the job market will be the key determinant in how quickly and by how much the Fed will reduce rates.”We are anyway past the phase at which a few basis points on monthly inflation is going to drive the rate path,” states Evercore. “This is now a labor data-first Fed, not an inflation data-first Fed, and the incoming labor data will determine how aggressively the Fed pulls forward rate cuts.”If August’s labor data shows improvement over July but continues on a softening trend, Evercore ISI expects the Fed to cut rates by 25 basis points at each remaining meeting this year, with further reductions potentially extending into early 2025.”This print is not so benign as to suggest the Fed has a totally free hand to focus on the labor market,” they write.However, if the labor market data shows significant weakening, the Fed might take more drastic measures, says the firm.According to Evercore ISI, should the data suggest a “cracking” labor market, the Fed could enact cuts totaling 200 to 250 basis points by the end of the year. Conversely, if the job market data is stronger than expected, the Fed may only implement two cuts this year.The analysts also noted that while the July CPI print was “not perfect,” it was sufficient to keep inflation concerns at bay, allowing the Fed to focus more on employment risks. The August jobs report, therefore, is poised to play a crucial role in shaping the Fed’s next moves. More

“The balance of risks has shifted, so the debate about potentially cutting rates in September is an appropriate one to have,” Kashkari told the Journal in an interview.Kashkari’s comments come after St. Louis Fed President Alberto Musalem and Atlanta Fed President Raphael Bostic made remarks that gravitated toward an interest rate cut next month.Kashkari said inflation was making progress but the labor market was showing “concerning signs,” according to the Journal.However, Kashkari said he did not see any reason to lower interest rates in increments of larger than a quarter percentage point because layoffs remained low and claims for unemployment benefits did not suggest a notable deterioration.Investors, who were earlier betting the Fed would have to cut rates by half a percentage point at its Sept. 17-18 meeting following weaker-than-expected labor market data are now pricing in a roughly 75% probability of a quarter-percentage-point cut next month after encouraging data on inflation, jobless claims and retail sales. More

However, the question is no longer whether the Fed will initiate a rate-cutting cycle, but rather how rapidly and significantly it will unfold, Citi economists said in a recent note.”We continue to see economic risks as tilted toward a more significant weakening in labor markets and the broader economy and dovish Fed policy risk as underappreciated by markets,” they wrote.Citi projects 50bp rate cuts in both September and November but expects Powell to avoid committing to specific policy decisions, reiterating that these are “data dependent.”A key aspect of Powell’s speech will likely be how he addresses the shift in risks, with concerns about the labor market now taking precedence as inflationary pressures ease. At the July 31st FOMC meeting, even before the unemployment rate rose to 4.3% and core inflation remained subdued, Powell had begun to highlight that the balance of risks was moving away from price stability and towards employment.The latest data, showing cooling inflation and a faster-than-expected softening of the labor market, provides Powell with two potential justifications for a more aggressive pace of rate cuts, Citi economists note.First, he might argue that as inflation decreases, the real policy rate – the nominal rate adjusted for inflation – effectively rises, necessitating a reduction in nominal rates to avoid overly restrictive monetary conditions.Second, Powell could cite the more rapid loosening of the labor market as a reason to bring policy rates back towards neutral more quickly. Despite stronger-than-expected retail sales and a decline in initial jobless claims, Powell is likely to maintain his view that the U.S. economy will avoid a recession.However, as the Citi economists point out, “with the ‘Sahm rule’ all but triggered, Powell’s intuition from July that downside risk to the employment mandate predominate should now be even stronger.”They believe Powell may use his Jackson Hole speech to reinforce the idea that policy is “well positioned” to respond to evolving data, possibly signaling that there is considerable scope to lower rates.“While he will stop short of clearly guiding toward or away from 50bp cuts, he will leave them on the table,” economists continued.The speech may also lay the groundwork for larger rate cuts, framing them within a clear macroeconomic rationale to avoid perceptions of “panic.” More

WASHINGTON (Reuters) – Four years after Federal Reserve Chair Jerome Powell made fighting unemployment a bigger priority during the COVID-19 pandemic, he faces a pivotal test of that commitment amid rising joblessness, mounting evidence inflation is under control, and a benchmark interest rate that is still the highest in a quarter of a century.High interest rates may be on the way out, with the U.S. central bank expected to deliver a first cut at its Sept. 17-18 meeting and Powell potentially providing more information about the approach to the policy easing in a speech on Friday at the Kansas City Fed’s annual conference in Jackson Hole, Wyoming.But with the Fed’s policy rate in the 5.25%-5.50% range for more than a year, the impact of relatively high borrowing costs on the economy may still be building and could take time to unwind even if the central bank starts cutting – a dynamic that could put hopes for a “soft landing” of controlled inflation alongside continued low unemployment at risk. “Powell says the labor market is normalizing,” with wage growth easing, job openings still healthy, and unemployment around what policymakers see as consistent with inflation at the central bank’s 2% target, former Chicago Fed President Charles Evans said. “That would be great if that is all there is. The history is not good.”Indeed, increases in the unemployment rate like those seen in recent months are typically followed by more. “That does not seem the situation now. But you may only be one or two poor employment reports away” from needing aggressive rate cuts to counter rising joblessness, Evans said. “The longer you wait, the actual adjustment becomes harder to make.”INFLATION VERSUS EMPLOYMENTEvans was a key voice in reframing the Fed’s policy approach, unveiled by Powell at Jackson Hole in August 2020 as the pandemic was raging, policymakers were gathering via video feed, and the unemployment rate was 8.4%, down from 14.8% that April.In that context the Fed’s shift seemed logical, changing a long-standing bias towards heading off inflation at the expense of what policymakers came to view as an unnecessary cost to the job market. Standard monetary policymaking saw inflation and unemployment inextricably and inversely linked: Unemployment below a certain point stoked wages and prices; weak inflation signaled a moribund job market. Officials began to rethink that connection after the 2007-2009 recession, concluding they needn’t treat low unemployment as an inflation risk in itself. As a matter of equity for those at the job market’s margins, and to achieve the best outcomes overall, the new strategy said Fed policy would “be informed by assessments of the shortfalls of employment from its maximum level.””This change may appear subtle,” Powell said in his 2020 speech to the conference. “But it reflects our view that a robust job market can be sustained without causing an outbreak of inflation.”A pandemic-driven inflation surge and dramatic employment recovery made that change seem irrelevant: The Fed had to raise rates to tame inflation, and until recently the pace of price increases had slowed without much apparent damage to the job market. The unemployment rate through April had been below 4% for more than two years, an unparalleled streak not seen since the 1960s. The unemployment rate since 1948 has averaged 5.7%.But the events of the last two years, and a coming Fed strategy review, have also triggered a wave of research into exactly what happened: why inflation fell, what role policy played in that, and how things might be done differently if inflation risks rise again. While the agenda for this year’s conference remains under wraps, the broad theme focuses on how monetary policy influences the economy. That bears on how officials may evaluate future choices and tradeoffs and the wisdom of tactics like preempting inflation before it starts.Some of that work is already emerging from Fed researchers, including top economist Michael Kiley. He has authored a paper questioning whether policy “asymmetry” – treating employment shortfalls differently than a tight labor market, for example – really helps. Another recent paper suggested policymakers who believe public inflation expectations are formed in the short-run and are volatile should react sooner and raise rates higher in response.The role public expectations play in driving inflation – and the policy response – was on full display in 2022. When it appeared expectations risked moving higher, the Fed pushed its tightening cycle into overdrive with 75-basis-point hikes at four consecutive meetings. Powell then used a truncated Jackson Hole speech to emphasize his commitment to fight inflation – a stark shift from his jobs-first commentary two years earlier.It was a key moment that put the U.S. central bank’s seriousness on display, underpinned its credibility with the public and markets, and rebuilt some of the standing that preemptive policies had lost.’TOO TIGHT’ Powell now faces a test in the other direction. Inflation is progressing back to 2%, but the unemployment rate has risen to 4.3%, up eight-tenths of a percentage point from July 2023. There’s debate over what that really says about the labor market versus rising labor supply, a positive thing if new job seekers find employment.But it did breach a rule-of-thumb recession indicator, and while that has been downplayed given other indicators of a growing economy, it also is slightly above the 4.2% that Fed officials regard as representing full employment.It’s also higher than at any point in Powell’s pre-pandemic months as Fed chief: It was 4.1% and falling when he took over in February 2018.The “shortfall” in employment that he promised to respond to four years ago, in other words, may already be taking shape.While Powell will be reluctant to ever declare victory over inflation for fear of touching off exuberant overreaction, Ed Al-Hussainy, senior global rates strategist at Columbia Threadneedle Investments, said it was past time for the Fed to get in front of the risk to unemployment – preemption of a different sort.Al-Hussainy said the Fed had proved its ability to keep public expectations about inflation in check, an important asset, but that “also has put in motion some downside risk to employment.””The policy stance today is offside – it is too tight – and that warrants acting on.” More

Goldman Sachs has cut its probability forecast for a U.S. recession to 20% from 25%, shortly after raising it from 15%.
After holding the odds at 15% for nearly a year, economists at Goldman — and elsewhere — were spooked by a weaker-than-expected July jobs report.
However, retail sales and jobless claims readings since then have signficantly eased concerns the world’s biggest economy is heading for a recession or is already in one.

Goldman Sachs has cut its probability forecast for a U.S. recession to 20% shortly after raising it, as fresh labor market data sparked a reassessment of market views on the economy.
Economists at Goldman earlier this month raised their 12-month U.S. recession probability from 15% to 25% after the U.S. July jobs report of Aug. 2 showed nonfarm payrolls grew by a less-than-expected 114,000. That was down from the downwardly revised 179,000 of June and below the Dow Jones estimate of 185,000. 

The report triggered widespread concerns about the world’s largest economy, and contributed to the sharp — but ultimately brief — stock market sell-off at the start of the month.
It also triggered the “Sahm rule,” a historical indicator showing that the initial phase of a recession has begun when the three-month moving average of the U.S. unemployment rate is at least half a percentage point higher than the 12-month low.
Goldman initially cited this as a reason for hiking the probability of an economic downturn — but changed tack on Saturday, when it wrote in a note that it saw the odds down to 20% because data released since Aug. 2 showed “no sign of a recession.”

That included retail sales for July — which rose by 1%, versus an estimate of 0.3% — and weekly unemployment benefit claims, which were lower than expected.
The figures prompted a change in mood which was reflected in a rally in global stocks late last week.

“Continued expansion would make the US look more similar to other G10 economies, where the Sahm rule has held less than 70% of the time,” Goldman economists said Saturday, noting that several smaller economies, including Canada, had seen sizeable unemployment rate increases in the current cycle without entering a recession.
Claudia Sahm, chief economist at New Century Advisors and inventor of the rule, told CNBC that she did not believe the U.S. was currently in a recession, but that further weakening in the labor market could push it into one.
A healthy jobs report on Sept. 6 would “probably” spur Goldman to cut its recession probability back to 15%, where it had been for nearly a year before August, the bank’s economists said.
Unless another downside surprise in the jobs report takes place, Goldman will become more confident in its forecast for a 25-basis-point rate cut at the Federal Reserve’s September meeting, rather than a steeper 50-basis-point trim, they added.
Markets have fully priced in a Fed rate cut in September, but have slashed the odds of a 50-basis-point reduction to just 28.5%, according to CME’s FedWatch tool.
Rashmi Garg, senior portfolio manager at Al Dhabi Capital, told CNBC’s “Capital Connection” on Monday she expected a cut of 25 basis points “unless we see a sizeable deterioration in the labor market in the September 6 jobs report.”
— CNBC’s Sam Meredith contributed to this story. More

$75 per monthComplete digital access to quality FT journalism with expert analysis from industry leaders. Pay a year upfront and save 20%.What’s included Global news & analysisExpert opinionFT App on Android & iOSFT Edit appFirstFT: the day’s biggest stories20+ curated newslettersFollow topics & set alerts with myFTFT Videos & Podcasts20 monthly gift articles to shareLex: FT’s flagship investment column15+ Premium newsletters by leading expertsFT Digital Edition: our digitised print edition More