Key Takeaways

  • Federal Reserve Chair Jerome Powell sent a clear signal ahead of the September meeting: the central bank will lower borrowing costs, citing a cooling labor market and progress on inflation moving back to the 2% target.
  • "The time has come for policy to adjust," Powell said in remarks on Friday, August 23, signaling that policymakers will lower the federal funds rate at their September 17-18 meeting. "Inflation is now much closer to our target," he said.
  • In explaining the upcoming policy shift, Powell said the Fed is now more focused on the health of the job market compared with earlier this year, and aims to avoid the widespread job losses that often occur during policy tightening. "We do not seek or welcome further cooling in labor market conditions."

In-Depth Analysis

Powell did not specify the size of future rate cuts, keeping alive the debate among investors and economists over how much policymakers will lower the federal funds rate from its current range of 5.25% to 5.5%.

"The direction of policy is clear," he said, adding that "the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks."

Following Powell's remarks, federal funds futures traders priced a 66% probability of a 25-basis-point rate cut next month and a 34% probability of a 50-basis-point cut, according to the CME FedWatch tool. On Thursday, the market had seen a 76% chance of a 25-basis-point cut and a 24% chance of a 50-basis-point cut.

Several central bank officials have recently voiced support for policy easing.

"If you look at the degree of tightness the Fed has set—the federal funds rate minus inflation—it's the highest in decades," Chicago Fed President Austan Goolsbee said after Powell's speech.

"You would only be that tight if you were trying to cool off an overheating economy, and the economy is not overheating right now," he said in an interview with CNBC.

"We also need to be as careful as Chair Powell about the employment side of the mandate. We're not just fighting inflation now—inflation is on its way to 2%," Goolsbee said.

Powell, speaking at a gathering of central bankers in Jackson Hole, Wyoming, said the personal consumption expenditures (PCE) price index rose 2.5% in the 12 months through June and likely held at that level last month.

According to minutes from the July 30-31 meeting released Wednesday, "several" Fed officials saw a case for lowering borrowing costs at the most recent gathering. The minutes showed that "the vast majority" of participants said that if price pressures continued to develop as expected, "it would likely be appropriate to ease policy at the next meeting."

Since early 2022, policymakers have made uneven progress in bringing inflation down from four-decade highs toward their target. The consumer price index (CPI) rose 2.9% year over year last month, a three-year low.

"The data are beginning to move in a direction that suggests our policy has worked, and we can begin to move back to a normal policy stance," Atlanta Fed President Raphael Bostic said on Friday.

"We can't wait until inflation itself gets to 2% to start acting," he told CNBC before Powell's speech, noting that the job market has not deteriorated sharply.

"There's no crisis in our labor market," he said. "My description would be that they're weakening, but not weak."

The unemployment rate rose to 4.3% last month from 4.1% in June, and nonfarm payrolls increased by only 114,000 jobs, below expectations and the smallest monthly gain this year.

Meanwhile, Bostic said policymakers cannot declare victory in the fight against inflation.

"If you look at where inflation is, it's not particularly close to our target," he said. "We have a dashboard of underlying inflation on our website, right? It's still all red lights."

Goolsbee also pointed to "warning lights," including consumer delinquency rates, small business default rates, and parts of the job market. "On the other hand, there are also broad areas of strength in our economy."