Is the Fed Really Ready to Cut Interest Rates?

After months of speculation and not a little exasperation, the Federal Reserve Board seems poised to finally lower the federal funds rate. While Federal Open Market Committee members and other Fed officials have been circumspect about the likelihood of an interest-rate cut, Fed Chair Jerome Powell let the cat out of the proverbial bag in a speech at the Kansas City Fed’s Jackson Hole, Wyoming economic symposium late last month.

“My confidence has grown that inflation is on a sustainable path back to 2%,” Powell said at the annual event. “The time has come for policy to adjust.”

Powell, ever vigilant to the nuances of Fed policymaking rhetoric, added a caveat that if the economy hits a rough patch or some other unforeseen event occurs to upset the economic apple cart, the central bank could reverse course and tighten monetary policy if necessary.

“The current level of our policy rate gives us ample room to respond to any risks we may face, including the risk of unwelcome further weakening in labor market conditions,” he said. And therein lies the rub.

Not all of Powell’s colleagues are as sanguine about the possibility of taking a pull of the monetary policy lever.

In another late August speech, FOMC member Michelle Bowman saw some good news on the inflation front but was not ready to go all in on a rate cut.

“The progress in lowering inflation since April is a welcome development, but inflation is still uncomfortably above the committee’s 2% goal,” she said. “We need to be patient and avoid undermining continued progress in lowering inflation by overreacting to any single data point.”

Earlier in the summer, Mary Daly, president of the Federal Reserve Bank of San Francisco was more succinct in her hesitancy to push for a rate cut.

“Monetary policy is working, but we need to finish the job,” she said.

So what is really worrying Fed officials?

The ghosts of the Covid-19 pandemic are still haunting the economic calculations of the Fed, especially when it comes to inflation. After erroneously characterizing the spike in prices in 2022 as “transitory,” the Fed may be a little gun shy when it comes to lowering interest rates.

While the economic boost from pent-up consumer demand was welcome after the worst of the pandemic passed, the Gordian knot of supply chain snafus threw a wet blanket over the idea of a sustainable, inflation-free recovery and sent Fed officials back to the drawing board. After missing the boat on transitory inflation, the supply chain crisis seems to have engendered a crisis of confidence in the Marriner Eccles Building in Washington where the Federal Reserve is headquartered.

In his Jackson Hole speech, Powell pointed to “pandemic-induced disruptions to supply and demand” as one of the main drivers of inflation. The “extraordinary collision between overheated and temporarily distorted demand and constrained supply” created the inflationary spiral that befuddled Fed policymakers for more than two years. And it may just be the thing keeping the FOMC to finally making a move in interest rates.

Acknowledging the pandemic economy was unlike anything the Fed has seen, rendering its assumptions and models less applicable, the Fed could be worried about another burst of pent-up demand fueling a spike in inflation, forcing more monetary policy tightening and scuttling any chance for the coveted “soft landing” for the economy.

After miscalculating the depths of inflation after the pandemic, Fed policymakers may be feeling once bitten, twice shy is the best way forward – for now.