Markets and strategies
The Fed, trapped by its optimism on the labor market
While several central banks in developed countries had already lowered their key rates (Canada, New Zealand, Sweden, Switzerland, Eurozone), the Fed also embarked on a cycle of rate cuts. And it did so with authority, by lowering its target range of key rates by 50 bps, to 4.75%/5%. Decoding by Bastien Drut, Head of Research and Strategy
Published on 24 September 2024
One can legitimately wonder why the Fed made such a turnaround. To answer this question, it is necessary to recall that the Fed has, unlike the ECB for example, a dual mandate with an objective of price stability and full employment. With the high inflation of 2022/2023, the Fed has been fully focused on the first of these two objectives, but the disinflation phase has been accompanied by a gradual deterioration in the labor market: the unemployment rate reached 4.3% of the labor force in July, compared to a cycle low of 3.4%.
The time has therefore come for the Fed to consider its two objectives in a balanced way. On August 23, at the Jackson Hole central bankers’ conference, Fed Chairman Jerome Powell had already declared: “We will do everything we can to support a strong labor market as we make further progress toward price stability” which suggested a clear intention to help the labor market if necessary.
But above all, the Fed has found itself trapped by its optimism about the labor market. In June, FOMC members had forecast the unemployment rate to be 4% by year-end and 4.2% by year-end 2025. But the unemployment rate exceeded those expectations over the summer and even triggered the empirical “Sahm rule”, which is supposed to date the onset of a recession based on how fast the unemployment rate is rising.
Fed members have long been convinced that the resilience of the U.S. economy would prevent a deterioration in the labor market, but that has not been the case because companies have cut back sharply on hiring programs and there are no longer enough jobs being created to absorb the influx of people entering the labor market.
In their defense, it must be said that the job creation figures may have seemed artificially high since a few weeks ago, the Bureau of Labor Statistics revised the total number of jobs downward by 818,000: never since the financial crisis of 2008 had such a downward revision been observed!
The Fed is maintaining a soft landing scenario since it expects 2% growth for 2024, 2025, 2026 and 2027. Jerome Powell explained: "we don't think we're behind but [we are cutting rates] as a sign of our commitment not to get behind."
The message is that there is nothing serious at work in the US economy, that is to say no "hard landing," but that this scenario must be eradicated for the coming months. It is precisely for this purpose that the Fed will continue the "recalibration" of its monetary policy, by continuing to lower key rates in the coming months.