The Federal Reserve is right to go slowly on rate cuts

If it were done when ’tis done, ’twere well it were done slowly, announced Federal Reserve Board chairman Jerome Powell last week. The Fed plans to cut its benchmark interest rate by 0.25 percentage points in November and again in December, rather than repeat its September cut of 0.50 basis points per cent to a range of 4.75 to 5 per cent. Faster please, sir — respond to those who foresee a recession unless the Fed cuts in 0.50 point steps.
Powell sees a soft landing ahead — inflation at or nearing its 2 per cent target, the labour market “healthy”. He is guessing that when all is done and dusted, the interest rate that will be neither restrictive nor stimulative, the neutral rate, will be about 2.8 per cent. So all is more or less well, then, as Powell pilots the economy to that legendary soft landing?
Not really. For one thing, the economy might be running hotter than the Fed believes, which would cause the stimulative effect of the rate cuts to reverse the downward trend of inflation. Most importantly, the jobs market that the Fed is so concerned to prevent from stumbling does not seem to need the help of lower rates. The economy added 254,000 jobs last month, almost 100,000 more than the upwardly revised figure for August. The unemployment rate dropped to 4.1 per cent from 4.2 per cent, and average hourly earnings are running 4 per cent higher than at this time last year.
There’s more to suggest that the economy is in what I believe is called in your country “rude health”. New orders for durable goods have been up in six of the past seven months, and the economy grew in the second quarter at an annualised rate of about 3 per cent, up from 1.4 per cent in the first quarter. Profits satisfy all save the greediest investors.
On the inevitable other hand, there are signs that higher interest rates have cooled the too-hot economy. Vehicle sales are down, the housing market has yet to benefit from a recent drop in mortgage rates, the manufacturing sector continues to slow, the collapse of the commercial property market is putting strains on regional banks, and lower-income consumers are pushing the limits of their credit cards.
Powell is giving most weight to the signs that inflation seems en route to the Fed’s 2 per cent target. Which is why he is cutting rates. But by moving slowly he is minimising the risk of events, dear boy, events — some unknown, others known unknowns — that might make a hash of his plans, and reverse the downward drift of the inflation rate. Among these are a war that could disrupt supply chains, and a political event that could continue a loose fiscal policy that offsets higher interest rates. Broken supply chains and government spending combined to contribute to the inflation rate that reached 9.1 per cent in June of 2022.
An explosion in the Middle East is certain, its economic impact less so. Tomorrow is one year since Hamas’s slaughter of the innocents, and since the start of Hezbollah’s rocket attacks that made northern Israel uninhabitable by its 60,000 residents. Israel has abandoned obeisance to its allies’ plea for restraint, and moved into retaliation mode. Just how far it will go in responding to last week’s 180-ballistic missile barrage from Iran is being decided in conferences in which Fed inflation concerns are not on the agenda.
It seems likely that Israelis will target Iran’s oil facilities. If they do, the mullahs threaten to retaliate with an attack on Saudi facilities. Even though oil supplies are currently ample, oil prices are already moving upward.
As for the threat that war poses to the smooth functioning of supply chains, the inflationary impact is shown by the 38 per cent rise in ocean freight rates from Asia to America’s West Coast after the Houthis’ closing of the Red Sea to shippers and crippling of the Suez Canal. Costs up, prices to follow.
Finally, we will soon have a new president with no interest in abandoning the old fiscal recklessness — meaning rising deficits and soaring debt. In the past, low interest rates and fiscal incontinence have been partners in the crime of triggering inflation.
Powell has little choice but to honour his pledge to lower rates in November and December. But he has little reason to surrender the flexibility he has quite sensibility reserved for the Fed. Data on the health of the economy and the labour market is ambiguous and subject to massive revisions. Israel’s next move will not be guided by a concern for the US inflation rate. Continued fiscal stimulus is more rather than less likely. Powell is probably right to aim for small, quarter-point cuts, rather than acceding to demands to proceed in giant, half-point steps.
Indeed, it is not unreasonable to believe that rate reductions will provide oxygen to revive a weakening inflation genie. If so, a U-turn to the status quo or rate increases would be more easily made if rate-cutting were travelling at a slow rather than a rapid speed.
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Irwin Stelzer is a business adviser