Powell may hope for replay of Fed circa 1995 even as he shuns "victory"
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[December 11, 2023] By
Howard Schneider
WASHINGTON (Reuters) - As victory celebrations go, the Federal Reserve's
announcement of a quarter point interest rate cut in July of 1995 was
hardly ostentatious.
"As a result of the monetary tightening initiated in early 1994,
inflationary pressures have receded enough to accommodate a modest
adjustment in monetary conditions," the Fed, then led by Alan Greenspan,
said as it began to loosen its grip on the economy after nipping
incipient inflation and with such good timing that the unemployment rate
continued what would become an eight-year decline. Job and economic
growth that had been ebbing into a possible recessionary spiral both
picked up.
It is a moment Fed Chair Jerome Powell and his colleagues want to
emulate, offering a case study of a “soft landing” from price pressures.
For Powell to complete the journey from allowing inflation to erupt on
his watch to navigating it back to the central bank's 2% target without
a recession, he will need to see the cycle through to that first rate
cut.
Conjecture over the timing is now in full swing.
Investors bet it will start no later than May, while new projections
from Fed officials on Wednesday after a two-day policy meeting are
expected to show rates lower by the end of 2024 but without any detail
on the timing of when cuts will start.
Policymakers will likely remain skittish about declaring victory over
inflation even though economic data increasingly resemble the conditions
Greenspan faced in 1995, with inflation seemingly set to slow, overbuilt
inventories posing a drag on future investment, a likely tightening of
government spending, and consumer spending expected to wane.
Back then that begged the question of why the Fed's rate should remain
as high as it was, at 6%. It's a query current Fed officials will likely
remain reluctant to answer for now, particularly after a strong November
jobs report.
The December meeting "is more likely to be a last hurrah for policy
caution," Evercore ISI Vice Chair Krishna Guha wrote ahead of the Fed
meeting. "We expect little specificity" around what will guide
policymakers toward the timing and extent of rate cuts.
PRICES, JOBS, CONSUMPTION, CREDIT
If 1995 is a guide, the case may hinge on how the job market, credit,
consumer spending and inflation itself all behave over the next few
months.
The Greenspan Fed as that year evolved became confident it had laid the
groundwork for continued "disinflation" since economic growth was below
potential and seemed poised to slow.
The Powell Fed may be approaching the same spot. Blow-out third-quarter
economic growth was driven by consumption and investment figures not
expected to be repeated, with overstocked inventories likely to drag on
output in coming months.
Consumer spending is also seen ebbing, in part as higher interest rates
slow consumer credit. Companies may also face tighter credit.
All of that should feed into diminished job and wage growth, and
steadily slowing inflation.
Consumer prices in October, indeed, did not increase at all.
What will foretell the pivot is Wall Street's new obsession.
Citi analysts argued recently that the job market "will become
increasingly important for the outlook for rate cuts," with continued
strength in hiring a reason to leave the current policy rate unchanged
in the 5.25% to 5.5% range.
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Federal Reserve Board Chairman Jerome Powell departs after holding a
press conference following a closed two-day meeting of the Federal
Open Market Committee on interest rate policy at the Federal Reserve
in Washington, U.S., November 1, 2023. REUTERS/Kevin Lamarque/File
Photo
The unemployment rate fell in November to 3.7% from 3.9%, and
three-month average job gains remain above 200,000, higher than the
183,000 in the 10 years before the pandemic.
Bank of America U.S. Economist Michael Gapen said he thought the cue
will come from the inflation numbers. Rate cuts come into view, he
said, once the Fed's targeted inflation measure, the Personal
Consumption Expenditures Price Index, falls "clearly below three" on
an annual basis, with the trend over three- and six-month time
frames perhaps at 2.5% or lower.
"That would give you further confidence that inflation is slowing,"
he said last month.
In Powell's latest comments he noted PCE had in fact hit 2.5% in
recent months, while Fed Governor Christopher Waller noted
separately that a continued steady decline in inflation for "three
months, four months, five months" would justify rate reductions
under many standard rate-setting rules.
If that progress stalls, however, rate cuts would be pushed further
out, and any sign of inflation resurgence likely met with renewed
discussion of further rate increases.
RISKS, NOT SHOCKS
Any cuts to come are also likely to lack any firm promises about
future reductions.
The Fed probably won't, as Waller noted, be trying to mount an
economic rescue, instead aiming to keep policy in line with falling
inflation.
It would be managing the risk, in other words, of restraining the
economy more than needed to finish its inflation fight, instead of
trying to open the monetary taps as happens in response to the sort
of shocks that can bring on recession fast.
The meltdown of tech stocks in 2000, for example, prompted the Fed
to chop nearly 5 percentage points from its roughly 6.5% federal
funds rate from January to December 2001. From September 2007 to
December 2008 the Fed cut rates in similarly aggressive fashion in
response to a housing market crash and financial crisis.
Greenspan's rate cut in July 1995, by contrast, wasn't followed by
another reduction until that December, and again in January. Rates
stayed steady from there until March 1997, when they were increased.
It was part of the "Great Moderation," an era when inflation become
anchored after the volatile spikes of the 1970s and 1980s, and both
growth and employment remained strong through much of the decade.
Powell has often cited similar periods of long expansion as the best
operating case, where the gains of low unemployment spread to the
less well-off, and households can make steady progress.
In his last public comments before the December meeting, Powell said
the coming period was one for the Fed to move "carefully" as the
one-sided risk of inflation came into more balance with the risk of
the Fed going too far.
"The risks of under- and over-tightening are becoming more
balanced," Powell said. "We don't need to be in a rush now...We're
getting what we wanted to get."
(Reporting by Howard Schneider; Editing by Dan Burns and Andrea
Ricci)
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