Federal Reserve Chairman Jerome Powell arrives to speak at a news conference following a meeting of the Federal Open Market Committee at the William McChesney Martin Jr. Federal Reserve Board Building. on July 31, 2024 in Washington, DC.
Andrew Harnik | Getty Images
If the Federal Reserve starts setting the table for interest rate cuts, some segments of the market are getting impatient for the dinner to be served.
“What are they looking for?” Claudia Sahm, chief economist at New Century Advisors, told CNBC shortly after the Fed’s meeting concluded on Wednesday. “The bar is being set pretty high and that really doesn’t make a lot of sense. The Fed needs to start this process gradually back to normal, which means gradually lowering interest rates.”
Known for formulating the Sahm rule that uses changes in the inflation rate to gauge when recessions occur, Sahm was calling for the central bank to start easing monetary policy so as not to drag the economy into recession. The rule states that when the three-month average of the unemployment rate is half a percentage point above its 12-month low, the economy is in a recession.
The 4.1 percent unemployment level is far from triggering the rule, and Sahm said the Fed’s insistence on keeping short-term interest rates at a 23-year high is putting the economy at risk.
“We don’t need a weak economy to get that last bit of inflation out,” he said. “We don’t have to fear a good economy. If the job of inflation is done, or if we’re on that glide path, that’s okay, the Fed can start to step aside.”
Asked about the Sahm rule during the post-meeting press conference, Fed Chairman Jerome Powell called it a “statistical regularity” that doesn’t necessarily apply this time as the jobs picture remains strong and the pace of wage growth slows.
“What is seen is a normalization of the labor market, job creation and a fairly decent level of wages that are growing at a strong level but gradually declining,” he said. “If it turns out that … it shows something more than that, then we’re in a position to respond.”
Careful approach
Markets, however, are pricing in an aggressive run for rate cuts starting in September with a quarter percentage point cut, which would be the first of the early days of the Covid crisis.
After that, markets expect cuts in November and December, with about an 11% chance of the equivalent of a full percentage point cut in the Fed Funds rate by the end of the year, according to CME Group’s FedWatch 30-day Fed Funds futures counter.
Instead of starting to take its foot off, the Fed said on Wednesday it was keeping its overnight lending rate in the range between 5.25%-5.50%. The statement after the meeting noted the progress made on inflation but also reiterated that policymakers at the Federal Open Market Committee rate-setting committee need “greater confidence” that inflation is returning to 2% before they are ready to cut rates.
DoubleLine CEO Jeffrey Gundlach also believes the Fed risks a recession by keeping a hard line on interest rates.
“That’s exactly what I think because I’ve been in this game for over 40 years and it seems to happen every time,” Gundlach said, speaking to CNBC’s Scott Wapner on “Closing Bell” on Wednesday. “All the other underlying aspects of the employment data are not getting better. They’re getting worse. And so once it starts to get to that upper level where they have to start cutting rates, it’s going to be more than they think.”
In fact, he thinks the Fed could end up cutting rates by 1.5 percentage points next year, a pace that is more aggressive than policymakers projected when they last updated their dot plot individual predictions.
Gundlach estimates that the consumer price index will soon be below 3%, making real interest rates, or the difference with the Fed Funds rate, particularly high.
“If you have a positive real interest rate that’s even one-and-a-half percent, that would suggest you have 150 basis points of room to cut rates without even thinking you’re overreacting to it,” he said. “I think they should have cut today, honestly.”
