The next Fed rate meeting is scheduled for September 18, but JPMorgan economists admit that an extraordinary Fed meeting could take place before then. Of course, its goal can only be a rate cut (market consensus forecasts imply a rate cut at the scheduled meeting and a 0.5 percentage point cut; the current Fed rate range is 5.25-5.5%).
The argument of those waiting for the extraordinary meeting of the Federal Reserve boils down primarily to the fact that the Fed probably made a mistake by not cutting rates at the last meeting on July 30-31, and that the overly restrictive monetary policy of the central bank supposedly brought the economy to the brink of recession, so it is necessary to react immediately , says Olga Belenkaya, head of the macroeconomic analysis department of the Finam financial group.
Many analysts refer to the recession trigger (the “Sam rule”), named after its author Claudia Sahm. It is that if the three-month average unemployment rate in the United States is 0.5 percentage points higher than the minimum of the previous 12 months, then the economy is in recession.
“The labor market report on Friday showed that the deviation was 0.53 percentage points, meaning the criterion was met. As the author notes, the rule has correctly indicated all recessions since 1970, and did not work outside of them in 1959 and 1969; the “government itself” worked outside of a recession, but the recession occurred within six months. Meanwhile, Claudia Sahm herself noted in a note in Bloomberg that although her government has historically worked correctly, the US economy is not yet in a recession (although the risks have increased), and that the result of applying the rules may be distorted by strong structural changes in the economy since the beginning of the pandemic,” says Belenkaya. For example, if the unemployment rate rises not because of a weakening demand for labor (as has historically most often happened before recessions), but because of an increase in the labor force (for example, due to an uptick in immigration), then this should not be considered an indicator of a recession, but the reasons for the rise in unemployment are not taken into account in the “Sam Rule”.
Recently, Goldman Sachs analysts raised their estimate of the probability of a US recession over the next year from 15% to 25%, but they still believe that such risks are limited. “They describe the state of the US economy as good, with no serious financial imbalances. However, fears about the economic slowdown have led to an increase in demand for protective assets, including gold and US government bonds,” notes Polina Shchukina, analyst at Digital Broker.
Last week, after the Fed meeting, Fed Chairman Jerome Powell signaled that the economy is approaching the point where it may be advisable to start cutting rates and confirmed that this could happen at the September meeting. The Fed has toned down its rhetoric, acknowledging that the risk is not only continued high inflation, but also excessive weakening of the labor market. According to Powell, current data do not indicate either an overheating of the economy or a rapid weakening of labor market conditions as a whole, which are returning to pre-Covid levels; if the labor market unexpectedly weakens or inflation falls faster than expected, the Fed will be ready to respond.
Federal Reserve officials speaking after the labor market report was released assessed the data as an argument for monetary policy easing, but saw no signs of a recession or threats requiring an emergency response. “The Fed almost never makes decisions based on one month of data. The market is now fully confident of a rate cut in September and a reduction of more than one percentage point by the end of the year, just a month ago. Rate cuts were expected before the end of the year. Against this background, both US government bond yields and mortgage rates have declined noticeably. Therefore, even without the Fed cutting rates, softening its signal and revising expectations serves to ease financial conditions, which should prevent excessive tightening of monetary conditions in the economy,” Little White notes.
Despite the unexpected rise in the US unemployment rate to 4.3% (the highest since October 2021) and weak job growth, as well as a number of other signs of cooling economic activity, objectively the situation of the US economy is not yet so good (alarming that it would require extraordinary reduction rates), the expert believes.
According to Belenkaya, the slowdown in the growth of the US economy and the cooling of the labour market as a whole correspond to the objectives of the Federal Reserve’s strict monetary policy and have not yet gone beyond the “soft landing” scenario, although the risks of transition to recession have increased somewhat. “As for the sharp collapse of global markets at the beginning of the week, it was caused not so much by real economic problems in the United States, but by a combination of several factors – in particular, the coinciding tightening of monetary policy by the Bank of Japan and a sharp revision of expectations regarding the path of interest rates by the Federal Reserve,” the expert notes.
According to her, an extraordinary rate cut by the Fed can only be justified if statistics confirm a rapid deterioration of the economy, particularly the employment situation, or if the fall in financial markets intensifies and becomes uncontrollable, thus endangering financial stability.
Additional reports on the US labor market and inflation will be released ahead of the Federal Reserve meeting on September 18, which will help clarify the economic outlook. In addition, the annual conference of global central banks will be held on August 22-24, where current assessments of the economic situation and the outlook for monetary policy will likely be given.
“If subsequent reports do not confirm a significant deterioration in the labor market and/or inflation does not slow sharply, then the Fed could start by cutting the rate by 0.25 percentage points in September and cut it by 0.75 percentage points before the end of the year. The Fed now has ample room for a rate cut to the long-term neutral level, which it estimates at 2.8%, and this buffer can be used if there is a threat of recession. However, inflation remains high, so the Fed is willing to do so. It probably remained cautious in the 1980s, when a premature rate cut led to a new round of inflation and the “unanchoring” of long-term inflation expectations; the way out of this situation required a higher rate level and a deep recession,” says Belenkaya.
According to Shchukina, if an emergency meeting of the Federal Reserve is held before September 18, the Fed could reduce the interest rate by 0.25 to 0.5 percentage points.
“The risks of a recession in the United States, combined with uncertain growth in China, may affect the Russian economy through a decrease in demand for raw material exports. A rapid reduction in the Federal Reserve rate may contribute to the weakening of the dollar against world currencies, but the ruble exchange rate is now less responsive to the situation on global financial markets than before due to the isolation of non-residents,” Belenkaya concludes.
