US Fed chief Powell greenlights Sept rate cut: 3 takeaways on inflation, jobs and recessionary fears

While the speech made it all but certain that the Fed would cut rates by at least 0.25 percentage points at its meeting in September, the quantum of the cut could be even more depending on incoming economic data between the Jackson Hole conference and the Fed meeting on September 17-18. The lack of any guidance is perhaps indicative of Powell’s intent to keep his options open at this point in time.

What was being closely tracked is the other crucial factor in the Fed’s dual mandate alongside that of keeping prices stable – the objective of ensuring maximum employment. Powell indicated that his worries were now tilting towards that side. “The upside risks to inflation have diminished. And the downside risks to employment have increased,” he said, clearly marking a crucial pivot in the Fed’s outlook on the employment versus jobs tradeoff. “The time has come for policy to adjust,” Powell said, clearly signalling the start of a new battle for the Fed after more than two years focused on controlling the post-pandemic stimulus-induced runaway prices. The Fed has kept its key lending rate at a two-decade high of 5.3 per cent since July last year, holding off on cuts that other central banks have already commenced.

It needs to be noted that the US has seen a recession – or a significant cooling of economic activity – after almost every time the Fed hiked interest rates in a sustained manner to control inflation. This time could be different, with the possibility of a ‘soft landing’ – or the possibility of sustained high levels of inflation being brought down through monetary tools without setting off a recession – looks highly achievable. In his speech, Powell took note of the sharp slowdown in the American job market, saying the Fed did not “seek or welcome further cooling”. This came as the US unemployment rate rose for the fourth straight month to a still-low 4.3 per cent in July.

Powell shrugged off concerns about another recession in the near future, arguing that the rise in unemployment was consistent with a slowdown in hiring, not a sudden spike in job cuts. “There is good reason to think that the economy will get back to 2% inflation while maintaining a strong labour market,” he said

The impact

Like other central banks such as the RBI, as the US Fed conducts monetary policy, it influences employment and inflation primarily by using policy tools to control the availability and cost of credit in the economy. The Fed’s primary tool of monetary policy is the federal funds rate, changes in which influence other interest rates — which in turn influence borrowing costs for households and businesses, as well as broader financial conditions.
When interest rates go down in an economy, it becomes cheaper to borrow; so households are more inclined to buy more goods and services, and businesses have an incentive to borrow funds to expand operations, buy equipment or to invest in new projects. Improved demand for goods and services ends up pushing up wages, and helps rekindle the growth cycle. Even though the linkages of monetary policy to inflation and employment are not direct or immediate, monetary policy is a key factor in curbing runaway prices or stoking the growth impetus.

Market reactions

A cut in rates in the US could have a three-pronged impact. When the Fed cuts its policy rates, the difference between the interest rates of the two countries could widen, thus making countries such as India more attractive for the currency carry trade. The lower the rate in the US, the higher the arbitrage opportunity, till the time that the rate cut cycle starts in other economies as well.

A lower rate signal by the Fed would also mean a higher impetus to growth in the US, which could be yet positive news for global growth, especially when China is reeling under the impact of a real estate crisis and showing signs of slowing down. Lower returns in the US debt markets could also trigger a churn in emerging market equities, improving foreign investor enthusiasm. There is also a potential impact on currency markets, stemming from inflows of funds.

For the RBI, like other central banks, the likelihood of a future rate cut is somewhat predicated on the Fed’s decision to cut rates. The RBI last cut the repo rate by 40 basis points to 4 per cent in May 2020 when the Covid pandemic raged across the country affecting the entire economy, leading to slowdown in demand, production cuts and job losses. Since then, the RBI has hiked the repo rate by 250 points to 6.5 per cent in order to tackle runaway inflation. The central bank has a mandate to keep inflation at 4 per cent, with a cushion of 2 per cent on either side.

Stock markets in the US rose after Powell’s comments, which sent the Dow, S&P 500 and Nasdaq all up more than 0.5 per cent, while bond yields tumbled. It is all but certain that the Indian stocks would see a rally when they open on Monday.