Federal Reserve Chairman Jerome Powell has unveiled his latest buzzword to describe monetary policy, a “recalibration” of policy at a crucial time for the central bank.
During his press conference after the Open Markets Committee meeting on Wednesday, Powell used no fewer than eight variations of the word in his attempt to explain why the central bank took the unusual step of cutting interest rates by half a percentage point despite no apparent economic slowdown.
“This recalibration of our policy will help preserve the strength of the economy and the labor market and will enable further progress on inflation as we begin the process of moving to a more neutral policy,” Powell said.
The financial markets were unsure what to make of the message the chairman delivered immediately after the meeting.
Asset prices soared Thursday, however, as investors took Powell at his word that the unusually large move was not the result of a substantial economic slowdown. Rather, it was an opportunity to “recalibrate” Fed policy from a rigid focus on inflation to a broader effort to ensure that a recent labor market weakness does not spiral out of control.
The Dow Jones Industrial Average and the S&P 500 reached new highs on Thursday after seeing wild swings on Wednesday.
“Policy was calibrated for significantly higher inflation. Now that inflation is approaching target, the Fed can reverse some of the aggressive tightening they've been doing,” said Tom Porcelli, chief U.S. economist at PGIM Fixed Income.
“It really allows him to push this narrative that this easing cycle is not about us being in a recession, it's about extending the economic expansion,” he added. “I think it's a very powerful idea. It's something we'd hoped he would do.”
Powell's buzzwords
Previous attempts by Powell to provide a high-profile description of the Fed's policies or its views on the economy have not gone well.
In 2018, markets reacted to his characterization of efforts to reduce bond holdings as being on “autopilot,” and his assessment that a series of rate hikes that same year had moved the Fed “far” from a neutral rate.
Even more famously, his claim that a rise in inflation in 2021 would prove “temporary,” caused the Fed to become so slow to act that it had to implement a series of three-quarter percentage point rate hikes to bring inflation down.
But markets showed confidence in Powell's latest assessment, despite his track record and some signs of cracks in the economy.
“In other contexts, a bigger move might convey more concern about growth, but Powell repeatedly stressed that this was in fact a joyous cut, as falling inflation allows the Fed to act to maintain a strong labor market,” Michael Feroli, chief U.S. economist at JPMorgan Chase, said in a client note. “Moreover, if policy is optimally set, it should bring the economy back to a favorable position over time.”
Still, Feroli expects the Fed will have to follow up Wednesday's action with a similar step at its Nov. 6-7 meeting unless the labor market reverses the slowing pattern that began in April.
There was also good news on the jobs front on Thursday, with the Labor Department reporting that weekly jobless claims fell to 219,000, the lowest number since May.
An unusual decline
The half-percentage-point (or 50 basis points) cut was notable because it marks the first time the Fed has gone beyond its traditional quarter-percentage-point measures without triggering a recession or crisis.
While Powell did not believe the measure was a catch-up measure because no cuts had been made at the July meeting, there was speculation on Wall Street that the central bank was indeed lagging behind in some sense.
“This is a case of maybe he felt like they were a little bit behind,” said Dan North, senior economist for North America at Allianz Trade. “A 50 basis point cut is pretty unusual. It's been a long time and I think maybe it was the last labor market report that gave him pause.”
Powell has never been shy about his concerns about the labor market. On Wednesday, he said that anticipating a potential weakening was a key motivation for the recalibration.
“The Fed continues to see the economy as healthy and the labor market as solid, but Powell noted that it is time to recalibrate policy,” wrote Seth Carpenter, chief economist at Morgan Stanley. “Powell has underscored and demonstrated with this rate cut that the FOMC is prepared to move gradually or take larger steps, depending on incoming data and how risks evolve.”
Carpenter is among those who expect the Fed to scale back its easing to quarter-point hikes for the rest of this year and into the first half of 2025.
However, futures traders are expecting a more aggressive pace, with the rate being cut by a quarter point in November but then again by half a point in December, according to the CME Group's FedWatch gauge.
Aditya Bhave, an economist at Bank of America, noted that the Fed had made a change to its post-meeting statement that included a reference to pursuing “maximum employment.” He said the comment indicated the central bank was prepared to remain aggressive if the jobs picture deteriorated further.
This also means that recalibration can be tricky.
“We think the Fed will ultimately cut rates more than it has signaled,” Bhave said in a note. “The labor market is likely to remain tepid and we think markets will push for another super-sized cut in the fourth quarter.”
