Jay Powell, chair of the Federal Reserve Board, announced last week that its monetary policy committee had cut the bank’s benchmark interest rate by a quarter of 1 per cent, to 4-4.25 per cent, while raising its forecast of economic growth, an unusual combination.
What he did not announce were two major changes in monetary policy, one immediate, the other impending. It is clear that the Fed has, in effect, abandoned its 2 per cent inflation target. More importantly, we now know that the president’s plan for his reconstituted Fed board will be every bit as radical as his reconstituted global trading system has turned out to be.
The board decided that weaknesses in the labour market, one in which the unemployment rate remains at the historically low level of 4.3 per cent, might add the “stag” to the “flation” now running rather hot, producing the stagflation that is any monetary policymaker’s nightmare.
• Fed makes first cut to US interest rates this year
That the labour market has come off its post-pandemic boil there is little doubt. Workers once prepared to jump jobs to greener pastures are now prepared to stay put; job seekers have become job keepers. Data revisions show that job creation has been a lot less than originally reported. Twenty-six per cent of the unemployed have found no work for more than six months, a three-year high.
Whether an interest rate cut can do much to maintain “maximum employment”, one of the bank’s two statutory mandates — the other is “price stability” — is far from certain. Some of the weakness in the labour market results from employers deferring hiring plans as they wait for the tariff picture to stabilise. Some is due to replacement of workers by AI, with more cuts to follow as the $3 trillion being invested in the technology reduces staffing requirements. Some is due to the swarm of recent college graduates sporting degrees of no relevance to the skills that employers are seeking. These structural changes are largely beyond the reach of the Fed’s monetary policy.
So much for the “stag”. Now for the “flation”, which Powell believes is the lesser of the two risks facing the economy: a jobs slowdown and even hotter inflation. Never mind that prices rose twice as fast in August as in July, their fastest pace in seven months. Or that the annual inflation rate is about 3 per cent, a full percentage point and 50 per cent above the Fed target of 2 per cent.
All this talk of mandates and targets is of interest to policy wonks and speculators masquerading as investors. It does not capture the reality that Joe Sixpack faces. He wakes up in the morning and downs a $3.75 cup of coffee, that only recently cost $2.50. That’s the largest annual jump in almost 30 years. If the family decides to grill a steak or hamburgers outdoors before the cold weather sets in, it pays 13 per cent more than just a few months ago for beef. And if that patio party was organised to celebrate the glorious day when the kids return to schools and colleges, they felt it in the wallet when their children’s supplies cost 9.4 per cent more than last year’s.
There is worse to come. Best guesses are that roughly a third of tariffs will eventually be reflected in prices that American shoppers pay for goods after businesses have used up their pre-tariff stockpiles. Insuring and repairing the family car will cost more, as will home insurance, healthcare and many other things, from electric utility bills to the price of shoes. Little surprise that Trump’s approval rating is down to 38 per cent, according to Pew Research Center pollsters.
More important than the Fed’s decision to assign a lower priority to inflation than to the jobs market are two policy developments. First, the Fed has again announced that it has postponed reaching its 2 per cent inflation target, this time until 2027. RIP that target, without benefit of Fed clerisy. Causes of death: practical irrelevance and neglect.
Second, we are on the brink of a new era of monetary policy. Stephen Miran, Trump’s once and future employee, shares his boss’s belief that the dollar is overvalued, that the cost of preserving its status as a reserve currency is not worth bearing, and that lower interest rates would reduce the cost of financing the national debt. He used his temporary seat on the Fed’s board to vote for a rate cut double that of the one approved by his 11 colleagues, and called for five more rate cuts to bring the bank’s benchmark rate down to 3 per cent, lower than the Fed’s projected inflation rate.
When Trump completes his hostile takeover of the Fed, King Dollar, already down 10 per cent since January, will drop further, a long-time Trump goal. But as investors flee dollar-denominated assets, the world’s central banks shed their dollar holdings in favour of gold and investors demand higher rates to cover the elevated risk of buying the Treasury’s IOUs, interest rates will turn up.
The president will have trumped the Fed, but not the bond vigilantes.
Irwin Stelzer is a business adviser