Apparently, the Federal Reserve (Fed) still has the sweet part of the job to do after the biggest rate hike in four decades: easing. While this may seem like a walk in the park, especially compared to the situation of controlling runaway inflation, the agency faces a tricky decision. As has happened on other occasions, the Fed is gambling on making a decision and getting the opposite effect of what it wants because of expectations, which can always play tricks. This time, the risk is that a 50 basis point rate cut, while it would stimulate the economy more than a 25 basis point cut, does not look good. The market could interpret this as an aggressive decision, reflecting the need to act forcefully in the face of an impending recession.
In other words, a half-point decrease could be digested as something more negative than positive, even if it would imply greater flexibility. There is an explanation, and it is that the concerns of the market and the Fed have changed. The focus is now on the American labor market. At its July meeting, the central bank’s statement paved the way for this turn of events since, for the first time, it did not only refer to price stability, but also to employment.
The Fed then acknowledged that it was assessing risks to prices and employment, a message that contrasted with previous ones that referred only to inflationary pressures. The market understood that the central bank was paving the way for the beginning of easing, but it also understood that it was time to focus on labor (and not inflation) in this part of the cycle. Therefore, any sign of weakness in labor indicators generates concern and volatility.
Later, Jerome Powell reinforced this message at the Jackson Hole meeting. At the meeting, he openly acknowledged that inflation was under control and that the focus was on not weakening the labor market. “The balance of risks to our mandate has shifted,” the central bank governor explained.
With inflation in the background, it is being assessed whether central bankers have gone too far in their restrictions, implying a risk of recession. A 50 basis point cut could be interpreted as a quick move by the Fed to end a potential crisis and avoid or cushion a hard landing for the economy.With 25 basis point adjustments having predominated in the cycle, the use of half a point could be interpreted as something exceptional and increase the uncertainty that has plagued the markets this week.
Analysts have already started to make this reading. Karen Manna, head of fixed income at Federated Hermes, says the market would not be moved by a 25 basis point cut, as it would signal that an “elusive” soft landing is still a possibility. But a 50 basis point cut, while it may imply an initial positive reaction, could lead to to greater volatility as fears of a recession take shape.
This week, employment data, along with other macroeconomic data, have been released in dribs and drabs, and investors have been looking for any signs of slowdown. The manufacturing PMI reflects the usual contraction that industry is mired in, but this time the market got scared and shed some of the risk. The employment data, which reflects weakness in the labor market, led to the worst session on Wall Street since Black Monday, August 5, the last time there was fear of a recession.
It is true that there are reasons to review portfolios. Fear of recession has surprised investors with stock markets at or near all-time highs.. Wall Street closed out August with the Dow at record highs, the S&P 500 just shy of its record high, and the Nasdaq 100 a little further behind. But in just four days, the U.S. stock market is on track for its second worst week of the year. There is volatility.
The Fed’s mid-month decision on September 18th could therefore come as a cold shower. This is not surprising since the central bank has benefited from the 50 basis point cuts With the onset of the pandemic, the credit crisis and after the dotcom bust, remember BloombergAt the next monetary policy meeting, with uncertainty in the stock market, U.S. officials will have to assess what is most favorable to the economy and what message they want to convey.
Tomorrow, there will be more information to understand if there are compelling reasons to be afraid. It is true that the labor market has weakened, but it remains to be seen whether this is simply a cooling or the prelude to a recession. To close out the week, the Bureau of Labor Statistics (BLS) will release official job creation figures and the unemployment rate. In its previous reading, unemployment had reached 4.3%, which is higher than the Fed’s last projection, dating back to June, which estimated unemployment at 4% for this year.
“US employment data remains critical to the trajectory of the US and, by extension, the global economy. And in this regard, underlying trends clearly call for caution, given that the risk of recession has unquestionably increased,” underlines Enguerrand Artaz, manager of La Financière de l’Echiquier (LFDE). A semi-circular cut can become in a sign that the market is confirming its worst suspicions.
