Top Federal Reserve officials have indicated they are open to half-point interest rate cuts in the coming months, even as they stress a more cautious approach at the next meeting.
This comes as the central bank responds to a softening labour market and a reduction in inflationary pressures, leaving the door open to more aggressive cuts if economic conditions worsen.
Governor Christopher Waller and New York Fed President John Williams both pointed toward the need for rate reductions following the release of a mixed jobs report last Friday.
The report showed 142,000 new jobs added in August and the unemployment rate ticking down to 4.2%, though the figures fell short of economists’ expectations for 165,000 new jobs.
Waller said the US economy was still performing well, but he acknowledged that “downside risks” had grown, necessitating action from the Fed to prevent further damage to the labour market.
He added that the economy remains on a solid footing but noted that he was open to larger cuts if economic data warrants it.
“If the data suggests the need for larger cuts, then I will support that as well,” Waller said, fueling a sharp rally in US Treasuries.
Treasury yields react as rate cuts loom
The possibility of larger interest rate reductions sparked immediate market reactions.
The two-year Treasury yield, which is particularly sensitive to interest rate changes, declined by 0.09 percentage points to 3.66%, while the 10-year yield fell by 0.05 percentage points to 3.69%.
This response suggests that markets are weighing the possibility of more aggressive monetary easing to combat slowing economic growth.
Williams, in his own remarks, echoed Waller’s cautious tone, emphasizing that the economy remains stable for now and that monetary policy is “well positioned” to maintain this stability.
However, Williams also stressed the Fed’s commitment to reacting to incoming data, highlighting that the central bank is not locked into a specific course of action.
Jobs report reveals softening labour market
The Bureau of Labor Statistics (BLS) released its August jobs report last week, showing an addition of 142,000 jobs, below economists’ expectations.
The report also revised July’s job creation figure down to 89,000, further fueling concerns about a labour market slowdown.
The job growth in August was driven by gains in the construction and healthcare sectors, while the manufacturing industry saw a decline in employment.
Although the unemployment rate dropped slightly to 4.2%, experts remain cautious about the trajectory of the US economy.
The monthly increase in average hourly earnings was 0.4%, which translates to a 3.8% annual increase — a figure that remains above pre-pandemic levels but lower than the recent highs.
Fed debates the pace of rate cuts
The upcoming Federal Open Market Committee (FOMC) meeting on September 17-18 is expected to result in a quarter-point rate cut, bringing rates down from the current 23-year high of 5.25% to 5.5%.
Some analysts, however, believe that expectations for a 0.5% cut are exaggerated.
“The market is overly worried about a recession, and this report shows that there is no sign of a recession,” said Torsten Slok, chief economist at Apollo Global Management.
There is no need to go 50 when the unemployment rate is falling.
Fed officials are closely monitoring the labour market as they work toward their goal of bringing inflation back to the 2% target, based on the annual change in the personal consumption expenditures (PCE) index.
Core PCE, which excludes food and energy prices and is favoured by policymakers, stood at 2.6% in August, down from more than 5% at its peak in 2022.
Inflation in focus as the economy stabilizes
The pace of job growth has slowed in recent months, with the average monthly job gain falling to 142,000, compared to a 12-month average of 202,000 jobs.
While sectors like construction and healthcare are still adding jobs, other areas such as manufacturing are showing signs of stress.
The data has led to concerns about the sustainability of economic growth.
Williams projected that the US economy could expand by as much as 2.5% this year, with the unemployment rate stabilizing at around 4.25%.
While these figures suggest stability, they also raise questions about how aggressively the Fed should cut rates moving forward.
David Kelly, chief global strategist at JPMorgan Asset Management, weighed in on the debate, saying that a larger initial rate cut could unsettle markets.
“I feel strongly that [the first cut] should be just 25 basis points,” Kelly said.
The Federal Reserve will unnerve everyone if they go 50. For psychological reasons, I think it’s much better that they just ease slowly.
As the Federal Reserve prepares for its next policy meeting, officials are signaling a cautious approach to rate cuts, while leaving the door open for more aggressive action if necessary.
With inflation easing and the labour market showing signs of softening, the central bank is likely to begin a slow path of monetary easing, though larger cuts remain a possibility depending on the data.
For now, the Fed will carefully monitor the economy to ensure it can navigate these uncertain waters without tipping the US into a recession.
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