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Fed Might Focus on Weakening Labor Market Rather Than Inflation as It Mulls Rate Cuts: Economists
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Helene Braun
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Thursday’s CPI report showed further signs of cooling prices although inflation is far from the Fed’s 2% goal.
However, the Fed might be more focused on the labor market, which could become a threat if it slows down significantly more.
Odds for a rate cut in September have increased to nearly 95%.
Markets, including crypto, briefly rose after Thursday’s Consumer Price Index (CPI) report which showed that prices cooled more than expected in June, spurring hope among traders that the Federal Reserve could indeed cut interest rates this year.
Even though Friday’s less-closely watched Producer Price Index (PPI) data came in hotter than expected, traders remained confident that the central bank will cut rates in September. Odds for that are currently just under 95%, according to CME’s Fed Watch tool.
The Fed has a dual mandate – to keep prices stable while also promoting maximum employment. A weakening labor market might thus force the Fed to begin easing monetary policy well before inflation returns to its 2% target (June’s CPI data showed inflation rising at a 3% year-over-year pace).
The U.S. unemployment rate has increased for three consecutive months to 4.1% in June from 3.8% in March.
“I do believe the labor market is going to be the bigger risk to the economy going forward,” said John Leer, head of economic intelligence at Morning Consult. “While it shows signs of cooling, it remains very strong by historical standards,” he added. “It would be a historical anomaly if the Fed manages to successfully engineer a soft landing, i.e., tame inflation without triggering a recession.”
Fed Chair Jerome Powell acknowledged the slowdown in the labor market at an appearance on Capitol Hill earlier this week, saying that it is no longer “a source of broad inflationary pressures for the economy.”
“The Fed will be worried that the negative trend may be a turning point for additional weakness in the labor market down the road,” said Olu Sonola, Fitch Ratings’ head of U.S. economic research. “Chair Powell did signal earlier this week that the balance of risk between the unemployment rate and inflation is now two-sided and the labor market is now back in balance. This gives them an incentive to start cutting rates sooner than later, now that inflation seems to be back on that path down to 2%.”
Even if the Fed starts to cut rates, this might not be as bullish of a signal as some traders think, 10x Research’s Markus Thielen said, given that investors in a weakening economy might choose to pull money out of risk assets – crypto included – in order to allocate it to safer investments.
