A shift in focus
As we covered in our previous article, Fed Chairman Jerome Powell’s brief but impactful speech at the Jackson Hole Economic Symposium clearly signaled that the institution’s focus is now moving away from concerns about inflation to concerns about employment.
In stating that the Fed ‘does not seek or welcome further cooling’ in the labor market, Powell made it plain that lowering rates is now firmly back on the table.[1] Other Fed committee members have since added their views that cutting rates at the next meeting is now a near certainty.[2]
As of the time of writing, the market is debating whether the September meeting will bring a 25 bps cut or a 50 bps cut. The consensus view is that rates will fall by at least two full percentage points by the end of next year.[3]
The driving forces
Many predicted that the Fed would be forced to cut rates far sooner in order to prevent a recession. Up to now, the US economy has been highly resilient despite high rates.
The July employment figures gave some cause for concern, ticking up to 4.3%.[4] While low by historical standards, rising unemployment is typically a sign of a cooling economy. Furthermore, a revision of the official figures showed that the US added approximately 800,000 fewer jobs than originally reported over the previous six months.[5]
The most recent employment figures, for August, showed a slight decline in unemployment to 4.2%, but the growth estimates for June and July were revised downwards by 86,000 jobs.[6] One Fed official said that data imply that the labor market is ‘continuing to soften but not deteriorate’.[7]
[Chart sourced from Wall Street Journal]
Inflation, meanwhile, appears to be within sight of its target, with Core PCE inflation at 2.6% and trending downwards over time.[8] Given that interest rates have a delayed effect on inflation, the Fed needs to think several steps ahead when it comes to balancing its two mandates of price stability and full employment. Now may well be the time to strike.
Source: U.S. Bureau of Labor Statistics
Conclusion
There are many imponderables in the road ahead. For instance, the result of the US elections later this year could have a major effect on US monetary policy and the economy overall.[9]
Long-term investors, however, have the luxury of being able to look beyond the short-term to the bigger picture. One interesting question to ponder is, what is the true ‘neutral’ interest rate, or in other words, where is the Federal Reserve heading eventually? The neutral rate is the level of interest that neither stimulates nor restrains economic activity, often seen as the equilibrium point that central banks aim for over the long term. Are we returning to an ultra-low interest rate environment (2000-2020) or something closer to the 1990s?
This is a highly complex question, and will be guided by megatrends rather than short-term shocks (see our own thinking here and here). In focusing on such broader issues, we are more likely to spot opportunities for sustainable outperformance (e.g. in new/resilient sectors), rather than fall prey to the hysteria of the herd.
[4] U.S. Bureau of Labor Statistics
[6] Bureau of Labor Statistics