Jerome Powell faces historic decision on US interest rate cut

Jerome Powell outlined the risks facing the U.S. economy three months ago as the Federal Reserve moved toward its first interest rate cut since the pandemic.

“It's a decision with serious consequences,” the Fed chairman told reporters when asked about the pace of easing in June, adding: “We want to get it right.”

With inflation concerns giving way to job worries, the Federal Reserve is set to begin the first of an expected series of interest rate cuts this week, finally providing Americans with some relief after more than a year of keeping borrowing costs at a 23-year high of 5.25-5.5 percent.

“This is likely the beginning of an easing cycle that will go a long way, and by that standard, this is a fairly significant meeting,” said Alan Blinder, who served as Fed vice chairman in the early 1990s under Alan Greenspan.

For Powell, the Fed’s ability to stave off further weakness in the labor market and achieve a “soft landing” will be pivotal to burnishing its legacy of guiding the global financial system through the biggest downturn since the Great Depression and the worst inflation crisis in decades.

Historians have cited the Fed's actions under Greenspan as among the most successful actions taken by a central bank to reduce inflation without causing a recession.

“That was when Greenspan became a god, but it was easy compared to what they’re dealing with now,” Blinder said of the Fed’s current leadership, which has had to deal with a pandemic, the war in Ukraine, and far worse inflation. “If Powell gets it right, [a soft landing]”He will be inducted into the Federal Reserve Hall of Fame.”

The Fed’s success may depend largely on how quickly it returns monetary policy to a more “neutral” environment that neither suppresses nor stimulates growth. Too rapid an easing process risks entrenching high inflation. Too slow an easing process risks causing unnecessary economic damage.

There are also historic gains for workers in the wake of the Covid-19 shock, as well as the potential impact on the US presidential election in November, where Kamala Harris and Donald Trump are running neck and neck in the polls.

Finding the right balance is a top priority for officials as they chart their policy course. They will make their first decision on Wednesday, whether to opt for a traditional quarter-point cut or start with a larger half-point cut.

Futures markets price the probabilities of either outcome equally.

“There is every reason to believe that the U.S. economy can achieve a soft landing with appropriate policy,” says Julia Coronado, a former Fed economist who now runs MacroPolicy Perspectives.

Coronado called for starting the rate-cutting cycle with a big half-percentage-point cut, and cutting rates by a full percentage point over the course of the year. She expects another 1.5 percentage points of cuts by the end of 2025.

Since the Fed’s last meeting in July, when many policymakers deemed a rate cut “acceptable,” data has been mixed. Inflation has eased, but there is some slack remaining. After a weak jobs report in July, monthly growth picked up in August as the unemployment rate fell. Other measures of demand, such as job openings, have continued to fall.

Against this backdrop, more than 90% of economists surveyed in the latest Financial Times/Chicago Booth poll believe the Fed will move gradually with a quarter-point rate cut on Wednesday, anticipating a soft landing.

“Communication is going to be everything here,” said William English, a Yale professor and former director of the Federal Reserve’s monetary policy department, adding that it will be “as important as the decision they make” in terms of the size of the move.

If they did 25 [basis points]“They want to make it clear that they are not behind and not aware of what is happening in the economy, and that they will move quickly if necessary,” he said. “If they do, they will have to take urgent action.” [basis points]“They want to make it clear that they are not on a fast track to neutrality.”

“It's easy to make a mistake in either direction,” he warned.

Ellen Meade, who served as a senior adviser to the Fed's board of governors until 2021, cautioned that neither option is likely to receive unanimous support, as most previous decisions under Powell have.

“Dissenters are really your friend in a close proximity,” she said, adding that it depends on who is dissenting as well as how many. “Having more than two dissenters would draw a lot of attention,” she added.

The rate decision will also be accompanied by a set of economic forecasts and an updated “dot plot” that aggregates individual officials' interest rate forecasts.

If the Fed starts with a half-percentage-point move, economists expect the dot plot to show a full percentage-point cut over the course of the year, suggesting two more quarter-point cuts at each of the remaining meetings.

But a quarter-point move could cap expectations at 0.75 percentage points over the same time period, or raise questions about why policymakers haven't started with a larger adjustment.

The US presidential election, which is looming over the Federal Reserve and the world’s largest economy more broadly, is now just seven weeks away from the September interest rate decision.

“The fall of a U.S. election year is always risky for the Fed and every government agency,” said House Financial Services Committee Chairman Patrick McHenry, a Republican.

The Fed seeks to stay out of politics, and as Powell has emphasized, the central bank makes its decisions based solely on “data, expectations, and the balance of risks.”

But Trump has already warned the Fed against cutting interest rates before the election, a view that some Republicans have rejected.

If Trump wins a second term, the fear is that he will escalate the hostile approach to the Fed that characterized his first term in order to more directly undermine its independence, which is codified in law and makes it accountable only to Congress.

But he is sure to face resistance. “There’s not much the president can do” to try to destabilize the Fed and its top officials, noted Gary Richardson, who served as the Fed’s chief historian from 2012 to 2016.

McHenry said he would “always” be a supporter of Fed independence, which “has benefited the U.S. dollar and long-term price stability.”

“There are a lot of risks out there, but I think Jerome Powell is as well positioned as anyone by his past conduct and by the relationships he has built with people in Congress to weather any storm that may come his way,” added Donald Kohn, a former Fed vice chairman.