Federal Reserve Chairman Jerome Powell’s speech at the Kansas City Fed symposium on monetary policy in Jackson Hole, Wyo., showed that the central bank is preparing for a policy pivot toward a rate cut designed to protect and preserve the economic soft landing achieved by the Fed.
In his statement, Powell said that “my confidence has grown that inflation is on a sustainable path back to 2%,” which is the signal that the Federal Reserve is preparing to cut rates.
In addition, by also saying that further cooling in the labor market is unwelcome, the Fed is unmistakably signaling that it is preparing to embark on a series of rate cuts.
Read more of RSM’s insights on the Federal Reserve and the middle market.
While market participants have priced in a 25 basis-point cut at the upcoming meeting on Sept. 18, it is critical for central bank policymakers to begin laying out the ultimate destination of policy.
The RSM forecast currently assumes that the Fed will cut rates by 25 basis points at each of the three remaining meetings this year and continue those cuts until it gets to somewhere near 3.25%.
Our modeling of the current state of play in the American economy and the central bank’s reaction function strongly suggests that the Fed’s neutral rate in the post-pandemic economy resides somewhere between 3% and 3.5%.
Powell and other Fed members will need to lay out the path of monetary policy in the coming year to shape investor expectations and reduce market volatility.
Our estimate of the Fed’s reaction function implies that the Fed, absent any significant deterioration in the economy, would reach our estimate of the neutral rate over the next nine to 12 months.
The risk here is that the fiscal path next year following the presidential election in November may result in varying inflationary pressures that could require the Fed to slow or even reverse that policy path.
In that case, market participants would need to adjust to the changing structure of the global economy wrought by the relocation of supply chains, industrial policy and intensifying geopolitical tensions, all of which have an implied inflation bias attached.
We expect that the upcoming policy review by the Federal Reserve will consider the obvious changes to the domestic and global economies.
The Fed will need to put forward an appropriate framework—including a possible new inflation target—to communicate the rapid changes affecting the economy to the public, policymakers and investors.
