The semiannual monetary report is nobody’s idea of a high-profile event. But at the Senate Banking Committee’s version of this hearing with Federal Reserve chair Jay Powell on Tuesday, a crack of daylight was pushed open in a way that should bring legitimate relief to the American people.
Powell, under questioning from Sen. Chris Van Hollen (D-MD), admitted that the balance of risks in monetary policy was shifting away from the inflation side of the Fed’s dual mandate, and toward the employment side. “The latest data show that labor market conditions have now cooled considerably from where they were two years ago, and I wouldn’t have said that until the last couple of readings,” Powell said in the Senate hearing. “We have to manage this process in a way that manages both of those risks. The two mandates are equal under the law.”
Later in the hearing, Powell said “this is no longer an overheated economy” and that “the labor market appears to be fully back in balance.”
This is indeed consistent with the data. Inflation, by the Federal Reserve’s preferred measure of personal consumption expenditures, is back to 2.6 percent by the last reading. If you take out housing, it’s actually just below 2 percent, the target number.
Meanwhile, the June jobs report, while showing 206,000 jobs gained, had substantial revisions to the April and May numbers. The average job gain for the last three months, at 177,000, is modest and not really showing an economy out of balance. The unemployment rate has moved from 3.4 percent last April to 4.1 percent last month. Wage growth has slowed, weekly hours have ticked down, and long-term unemployment has increased. And there is no longer an excess of unemployed workers relative to job openings; that number is at pre-COVID levels.
Interest rates have been stuck at 5.5 percent for a year now. Yet Powell would not give any indication of the timing of a rate cut, and Republicans on the panel, when they weren’t shilling for big banks over lowering capital requirements, seemed to suggest that it would look too overtly political to cut rates before the November election.
In other words, the meaning of Fed independence is to follow the data, unless there’s a president in office who might benefit from that following of the data, which last I checked there always is.
The continued high interest rates have a much greater effect on 330 million people than one resident of 1600 Pennsylvania Avenue, Washington, D.C. In particular, they have had a grave effect on building. Thanks to the Inflation Reduction Act and CHIPS, manufacturing investments have soared. But because those investments are financed, they simply don’t stretch very far anymore. If you adjust for inflation, nonresidential construction is right back on trend, having fallen for five straight months.
Powell admitted that the balance of risks in monetary policy was shifting away from the inflation side of the Fed’s dual mandate, and toward the employment side.
Moving from investors to consumers, the high cost of credit is just as debilitating, frustrating efforts at large purchases through mortgages or auto loans. Sales of existing homes have fallen by more than 30 percent since 2021. “Hundreds of thousands of potential first-time buyers are being kept out of the housing market,” writes Center for Economic and Policy Research economist Dean Baker. “Millions of homeowners who might otherwise sell their homes are keeping them off the market and being prevented from making moves they want to make.”
None of this means we’re necessarily headed to recession. But it means that a 5.5 percent interest rate environment is having a damaging effect, and its primary purpose, to cool the labor market and rein in inflation, is no longer relevant.
The next Federal Open Market Committee meeting to decide the path of interest rates is at the end of this month. To the extent that Fed governors have spoken in public, they have generally brushed aside any chance of an interest rate cut; the smarter money says September would be the target date. But this could be too late to reverse the growing risks to employment.
“It’s only the Fed that have really boxed themselves in,” said Skanda Amarnath, executive director of Employ America, who supports a July rate cut if the data for the rest of the month, particularly the inflation numbers, follows the current trend. “I think the Fed has precommitted to an outcome that may be highly misaligned with the fundamentals.”
Baker also cites the weakness in the commercial real estate market and the threat to safety and soundness of the banking system. A high-interest-rate environment is not a good place to be if banks start suffering. “The Fed can’t design monetary policy with the idea that it should try to limit inflation in the event some crisis occurs,” Baker writes. “It needs to respond to the economy that it is seeing at the time. And right now, this economy is arguing for lower rates.”
As Sen. Van Hollen said on Tuesday, the risk of not acting soon enough to prevent further increases in unemployment outweighs the risk of acting too soon and reversing the softening inflation trend. The Fed can either be wrong again by waiting too long, or learn from their mistake. The independent thing to do would not be to deny the data because of the political calendar, but to follow the data regardless of it.