Federal Reserve Chair Jerome Powell recently indicated that, without the impact of former President Donald Trump’s trade war, interest rates would likely have already been lowered this year. Now critics have shifted their ire towards the Fed for its delayed response to inflation in 2021. At the same time, fears are rising in response to a softening labor market.
The Fed’s decisions are being watched closely as a notable economic faceplant is evolving with the strongest signals pointing to a sizable slowdown in job creation. Last week, the Labor Department announced a whopping downward revision of 911,000 jobs for the year ending in March. This $8.4 million adjustment is the biggest change in history. This unexpected development has led many to question the validity of earlier forecasts and the usefulness of existing monetary policy.
Historical Context of Fed Decisions
In 2021, the Federal Reserve faced backlash for its slow response to escalating inflation rates, which many experts deemed transitory at the time. Powell, like his fellow Fed officials, had promised inflationary pressures would be transitory. But those forecasts didn’t come to pass the way they anticipated.
Flash forward to 2023, and forecasters and Fed economists alike had pronounced an inevitable recession that never happened. This disconnect has, in turn, caused distrust in the Fed’s capacity to accurately read economic developments.
It likely heaps further pressure on central bankers to get their policies just right, which James Knightley, chief international economist at ING, said was the hard task.
“Labor market momentum is being lost from an even weaker position than originally thought, reinforcing expectations of meaningful interest rate cuts.” – James Knightley, chief international economist at ING
The economic reality hasn’t waited for the world to change, with every industry just about reporting greater losses than additions on their jobs tables. This trend has added fuel to the fire to speculation over what the Fed’s next move will be on interest rates.
Current Economic Indicators
New data from the Labor Department shows that the pace of job growth has collapsed since the month of March. In fact, more industries are losing jobs than gaining them, sounding sirens that all is well in the economy’s job market.
The lasting effects of tariffs enacted during Trump’s term have been felt ever since, according to St. Louis Fed President Alberto Musalem. These tariffs are still reverberating through the economy.
“The effects of tariffs will work through the economy over the next two to three quarters and the impact on inflation will fade after that.” – St. Louis Fed President Alberto Musalem
This long-lasting effect has made for a hostile environment for businesses, many of which are already being crushed by tariff-related stresses. San Francisco Fed President Mary Daly, among others, noted that these price hikes would be transitory.
“Tariff-related price increases will be a one-off.” – San Francisco Fed President Mary Daly
As economic conditions evolve, Powell has opened the door to potential rate cuts in a recent keynote speech at the Kansas City Fed’s annual economic symposium. On the ground, this change in tone really matters. Just last month he was claiming that the labor market was still strong while admitting to a few downside risks.
Implications for Future Monetary Policy
Now economists are trying to understand what all this means for the future course of monetary policy. In accepting his award, Chicago Fed President Austan Goolsbee recognized the difficult art of sailing in these murky waters.
“We’re going to have to figure it out.” – Chicago Fed President Austan Goolsbee
Kent Smetters, an economics professor at the University of Pennsylvania’s Wharton School, highlighted a key principle of monetary policy—its inherent lag in stimulating the economy.
“Monetary policy lags in terms of how much it stimulates the economy, so, ideally, it should move a couple months ahead of weaker jobs numbers.” – Kent Smetters
Ellis futures are pricing in rate cuts before year end. Thanks to a rapidly depleting labor market, the central bank now appears on track for its first interest rate decrease since December. Business analysts are calling this move imperative to bolster economic confidence as uncertainty hangs in the air.