Three reasons the Federal Reserve is likely to cut interest rates soon
Any soft landing needs a little bounce.
At this point, there’s really no doubt that the U.S. economy has achieved a soft landing. Even at an incredibly low unemployment rate of 3.7%, the jobs numbers are still surging — payrolls increased by over 350,000 in January, beating expectations, and past numbers were revised upward. The prime-age employment rate — my favorite indicator of the labor market — ticked up to its pre-pandemic high of 80.6%:
And all this is happening while wages are accelerating. In nominal terms, average hourly earnings increased at an annualized rate of 6.6%, which is almost certain to be substantially above the rate of inflation:
And yet at the same time, inflation has fallen back to the 2% target:
This is a remarkable macroeconomic feat. Very few people thought that the Fed would be able to quell the post-pandemic inflation without throwing large numbers of people out of work, but somehow they pulled it off.
The next big question is: Will the Fed cut rates this year? Great fortunes could hang on that decision, as could the short-term fate of the U.S. economy. But the answer is surprisingly unclear. Jerome Powell recently downplayed the likelihood of a March cut:
Jerome Powell delivered a clear message to traders eager for the central bank to start slashing interest rates: Not so fast…Powell forcefully pushed back on hopes of a first move at the next meeting in March — saying it’s unlikely to act that quickly as it waits for more signs that inflation is pulling consistently back to its target.
The obvious reason not to cut rates soon is that the economy is doing so well. Standard macroeconomic intuition says that when everybody has a job and wages are going up, people are going to buy more stuff, which is going to put upward pressure on prices eventually. So one basic strategy for monetary policy is to lean against a strong economy.
On top of that, there’s just the general intuition of “if it ain’t broke, don’t fix it.” If 5.33% interest rates haven’t hurt the real economy so far, and if they’ve managed to bring inflation back down to target, why would you rock the boat by going back to low interest rates?
That being said, I do think it’s likely that the Fed will start cutting rates fairly soon, if not in March then sometime in the three months afterward. There are basically three reasons why it makes sense. First of all, and most optimistically, we have what appears to be accelerating productivity growth.