The Powell Effect: Markets Await Fed Chair’s Words as Economists Warn of Policy Error

A new survey of economists released as Federal Reserve Chair Jerome Powell was scheduled to speak on Monday indicates that the primary danger that could undermine the economy over the next year is a mistake made by the U.S. central bank in setting interest rates during the final phase of its inflation battle.

The National Association for Business Economics recently conducted a survey of 32 professional forecasters, and 39% of them identified a “monetary policy mistake” as the “greatest downside risk to the U.S. economy over the next 12 months.” In contrast, 23% identified the outcome of the Nov. 5 U.S. presidential election as the most significant downside risk, and the same proportion identified an intensification of the conflicts in the Middle East and Ukraine.

The survey responses, which were released on Sunday, demonstrate the intense focus on the Federal Reserve as it eases monetary policy in an effort to maintain inflation at its 2% target and prevent a substantial increase in an unemployment rate that has been in a state of modest increase for the past year.

Powell is scheduled to address the association in Nashville, Tennessee at 12:55 p.m. CDT (1755 GMT). He is expected to provide further details on the Federal Reserve’s decision to reduce its benchmark interest rate by half a percentage point at its meeting on September 17-18. Additionally, Powell is expected to discuss the factors that will shape an anticipated sequence of borrowing cost reductions throughout the remainder of the year and in 2025.

At its policy meeting on November 6-7, the Federal Reserve is anticipated to reduce rates by either a quarter or half of a percentage point.

The discussion regarding that decision has already commenced. Fed Governor Michelle Bowman, who opposed the half-percentage-point cut on Sept. 18 in favor of a quarter-percentage-point reduction, observed that the personal consumption expenditures price index, which excludes food and energy costs, had slightly increased in August during her remarks at a bank conference in South Carolina on Monday.

Despite the fact that “core” inflation has been declining, the rate of progress has remained relatively consistent between 2.6% and 2.7% on a year-over-year basis for the past four months. Bowman criticized that approach on Monday, despite the fact that some Fed officials have observed that measurements over a limited three- or four-month horizon have been significantly weaker.

She stated that the year-over-year measure “offers a more comprehensive perspective than the more volatile higher-frequency readings” that certain Federal Reserve officials have employed to justify the larger reduction. Although the year-over-year measure has also decreased marginally since the spring, there has been limited recent progress, and in August, it was 2.7%, which is still significantly higher than our 2% objective. “Core inflation remains uncomfortably elevated above the 2% objective of the Federal Open Market Committee.”

However, Fed officials and economists who participated in the most recent survey contend that the labor market and the economy are facing escalating risks. The NABE’s survey revealed that 55% of respondents believed it was more probable that the economy would underperform than anticipated, with Fed policy being the most likely obstacle.

The panel at the median currently predicts that U.S. economic growth will decline to 1.8% next year, down from an estimated 2.6% this year. The unemployment rate is expected to rise to 4.4% from the current 4.2%, and inflation is expected to end at 2.1% next year.

A recession was not anticipated by at least two-thirds of the respondents until 2026.

‘Just in time’

Powell and the Federal Reserve would undoubtedly celebrate such outcomes as a textbook “soft landing.” Without a recession or a significant increase in the unemployment rate, inflation, as measured by the headline PCE price index, has decreased from a high of over 7% in 2022 to 2.2% last month. Although the jobless rate has increased to 4.2% from the low of 3.4% last year, which was the lowest in half a century, it continues to be significantly lower than the average of 5.7% documented in Bureau of Labor Statistics data since the late 1940s.

However, there is a significant amount of disagreement regarding the most effective approach to completing the task, which underscores apprehensions regarding the Federal Reserve’s capacity to prevent either the economy from slowing down unnecessarily by maintaining financial conditions and borrowing costs at an excessively high level, or the economy from rebounding inflating at an excessively rapid pace.

The current policy rate is where it should be following the Fed’s recent rate cut, according to the median of the panel’s forecasters. However, there was a fairly even split on this issue, with a majority of the panelists believing that the central bank is already off course.

The rate adjustment was “just in time,” according to 65% of the respondents.

However, the survey revealed that only one-third of respondents believe the current policy rate is “just right,” while another third believe it should be less than 4.75% and 30% believe it should be 5% or higher.

Respondents were divided regarding which election outcome represented the most significant economic hazard, in addition to other risks that were identified.

One party’s control of the White House and Congress can facilitate decision-making on matters such as the debt ceiling or budgetary allocations. However, it can also provide the president with additional discretion to implement campaign pledges, including trade policies or tax reductions.

In contrast to 10% who perceived a Democratic sweep of the executive and legislative branches of government as a threat, 13% perceived a Republican sweep of the White House and Congress as a negative risk.

In contrast, 7% of the respondents expressed a favorable opinion of a Democratic or Republican victory.

17% of respondents perceived divided governance as a negative risk, while 13% perceived it as a positive risk.