Fed's predicament intensifies as a crucial inflation measure escalates
The Federal Reserve, the United States' central banking system, found itself in a delicate position in September 2019, as it lowered interest rates in a bid to support economic growth and prevent inflation from falling too low. This decision came amidst concerns about slowing inflation, ongoing tariff uncertainty, and signs of labor market cooling.
The Fed reduced the federal funds rate by 25 basis points to a target range of 1.75%-2.00%. This move was part of a series of three cuts in 2019, aimed at sustaining the economic expansion and offsetting tariff-related headwinds.
Inflation during this period was relatively subdued, below the Fed’s 2% target. The ongoing trade disputes, particularly between the US and China, created significant economic uncertainty, raising costs for American businesses and consumers. This uncertainty was a key factor in the Fed's cautious monetary stance.
The labor market in 2019 remained relatively strong, but some signs indicated a slowdown. Job growth was moderating, and there were concerns about weakening conditions that could presage broader economic softness. The Fed aimed to sustain employment with accommodative policies, signaling its awareness of the labor market’s importance in its dual mandate (maximum employment and price stability).
Fast forward to July 2021, the economy added only 73,000 jobs, and the unemployment rate stood at 4.2%. This lacklustre job growth, coupled with sharp downward revisions to previous monthly job gains, has led economist Derek Tang to consider the July jobs report a wake-up call for those counting on the resilience of the US economy.
The Federal Reserve has indicated it expects to cut interest rates by a cumulative 50 basis points this year, according to projections from the Fed's June meeting. Traders expect the Fed to reduce the federal funds rate by 25 basis points when it meets next month.
Meanwhile, the confirmation of Stephen Miran, a Trump ally and Fed critic, to temporarily fill the seat vacated by former Fed governor Adriana Kugler, is pending in the US Senate. If confirmed, Miran would add a third prominent voice to the Fed advocating for lower interest rates.
However, the Fed is facing a dilemma due to pressure from the White House to cut interest rates. Federal Reserve chairman Jerome Powell has warned that the Fed could find itself in a position where these two goals conflict due to the effects of tariffs. Trump has continued his pressure campaign against Powell, threatening to allow a lawsuit against him to proceed due to his management of the construction of the Fed Buildings.
The Federal Reserve's rate-setting Federal Open Market Committee consists of the chairman, six other members on the board of governors, the New York Fed president, and four of the 11 regional presidents who serve on a rotating basis. The Federal Reserve has a dual mandate of price stability and maximum employment.
In July, the consumer price index rose 2.7% annually, less than expected, but core inflation (excluding food and energy) rose 3.1% year on year, the highest since February. Medical care services and airfare prices were also above recent trends, contributing to the rise in core inflation.
Christopher Waller and Michelle Bowman, two Trump appointees on the Federal Reserve Board, have suggested that rate cuts should come sooner to protect the labor market. This call for immediate action comes as prices for imported items such as household furnishings, apparel, and recreational goods increased last month.
As the Fed navigates this complex economic landscape, it must strike a delicate balance between supporting growth and preventing inflation from falling too low, all while managing the risks posed by tariff-related uncertainties and signs of labor market slowdown. This measured easing is intended to prolong the economic expansion without triggering undue inflation or overheating.
- The Fed is expected to reduce the federal funds rate by 25 basis points when it meets next month, reflecting its intent to support economic growth and prevent inflation from falling too low.
- The ongoing trade disputes and tariff-related uncertainties have created significant economic distress for American businesses, increasing their costs and placing pressure on the Fed to act.
- In July, the consumer price index rose at a lower rate than expected, but core inflation (excluding food and energy) saw a significant increase, reaching its highest point since February.
- The potential confirmation of Stephen Miran, a Trump ally and Fed critic, could add a third prominent voice to the Fed advocating for lower interest rates, further pressuring the Fed to act.
