Why Powell is even more powerful after the jumbo cut

Fed Chairman Jerome Powell has emerged even more powerful after leading the US central bank to a major interest rate cut. The markets have largely welcomed the decision, while stock markets are racing from record to record. The prevailing assumption is that the Fed has initiated the interest rate turnaround in time and will succeed in a soft landing for the economy. On the other hand, the central bankers’ aggressive approach has also increased expectations of future cuts. Market participants are expecting a probability of over 60% that the US central bank will cut interest rates again by 0.5 points in November. Powell could provide new clues about the Fed’s future path in his speech today.

Reasons for the jumbo interest rate cut

A week before Federal Reserve policymakers met in Washington this month, they were still divided over how quickly interest rates should be cut, according to a Bloomberg report.

The economy was not showing the obvious warning signs that would normally prompt an aggressive response from the Federal Reserve. But a strikingly weak series of labor market data, including the August employment report on the Friday before the Fed’s latest meeting, had convinced Chairman Jerome Powell that a larger-than-usual rate cut was needed to hedge against rising labor market risks. Two inflation reports in the same week showing that price pressures continued to ease finally sealed the Fed’s decision.

When the Fed announced its decision on Sept. 18, forecasts showed that a slim majority of officials favored cutting the benchmark interest rate by a full percentage point or more this year — meaning at least one big cut. But a sizable minority expected only 75 basis points, suggesting three smaller moves.

In the end, however, all but one of the 12 voting members of the Federal Open Market Committee supported Powell’s proposal to start with a half-point cut in interest rates, a major victory for the chairman who is trying to extend an economic expansion that many had long ago declared over. The lone holdout, Governor Michelle Bowman, is instead calling for a more measured pace of rate cuts so as not to undermine progress on inflation.

Powell shows the way

“The chairman always has enormous power,” said Mark Spindel, founder of Potomac River Capital and co-author of a book about the Fed and Congress. “It’s a clear success that Powell managed to get everyone on board except Bowman, and he’s now a powerful even more chairman.”

At a press conference following the meeting, Powell called the half-point cut a “good, strong start” that made sense from both an economic and risk management perspective.

A further 50 basis point rate cut cannot be ruled out if the economy begins to falter, economists say, as Powell prioritizes keeping the economy close to full employment while inflation cools.

Powell may have a chance to convince his colleagues to make another big rate cut in the coming months if jobs data disappoints again. A number of officials speaking out in recent days have signaled they are likely to support a quarter-point rate move in the future, but left the door open for another big cut.

“Given his comments in Jackson Hole and what we heard from him at the press conference, I think Chairman Powell would be inclined to cut rates by another 50 basis points if there were further weakness in the labor market,” said Matthew Luzzetti, chief U.S. economist at Deutsche Bank.

Three key moments

Powell demonstrated his leadership at three key moments last year.

He signaled a possible peak in interest rates in December 2023, at a time when some Fed members believed they would have to raise rates further. After a surprise spike in inflation in the first quarter of 2024 that alarmed many Fed officials, he kept rates steady until he gained confidence that price pressures were easing. Some politicians from both parties complained he was putting the economy at risk. Eventually, he decided on a sharp rate cut as a first step.

All of these measures were guided by the belief that high interest rates would cool – but not destroy – the economy and that inflation could be tamed at lower job costs.

“Our success in achieving these goals matters to all Americans,” Powell said at his press conference on September 18. He described the rate cut as insurance against a further economic slowdown – an act of risk management.

“You can see this as a sign of our commitment not to fall behind the curve,” Powell said last week. “It’s a stronger step.”

Untypical approach

A 50 basis point rate adjustment is atypical for the Fed outside of a crisis. One fear was that it could be a sign that the Fed is worried by signs of an economic slowdown. Powell instead said the move was a sign of confidence that inflation was on track to return to 2%. He underscored, with a rare admission that a larger move was his own strong preferences, that he was “comfortable” with the decision.

The latest labor market report showed not only that employers added fewer jobs in August than forecast, but also that the pace of hiring was weaker than originally estimated for the previous two months. The number of people employed fell by 86,000 in June and July, the lowest three-month average since mid-2020.

Risk management, a strategy the man introduced under former Chairman Alan Greenspan, called for fending off potential threats even when they seem unlikely. And with the Fed’s benchmark interest rate still in hawkish territory after a half-point cut, the cost of a big rate cut was seen as low by several officials.

“Even after the 50 basis point cut, I believe the overall monetary policy stance remains tight,” Minneapolis Fed President Neel Kashkari wrote in a Sept. 23 essay, explaining why he supports the larger move.

Lively debate

Powell’s schedule shows that he holds talks with all 18 of his counterparts a few days before each FOMC meeting. These discussions give officials a sense of where the chairman stands. Powell’s emphatic justification for the larger rate cut at the press conference suggested that he preferred the half-point cut in the week before the meeting.

Some Fed officials who spoke after the meeting described the meeting and the period leading up to it as a lively debate.

“There was active deliberation at the meeting,” Kashkari said in a Sept. 23 interview on CNBC. “There was, of course, a lot of discussion leading up to the meeting.”

Atlanta Fed President Raphael Bostic said the two weeks before each FOMC meeting are a time of “intense discussions.”

In a question-and-answer session following a Sept. 23 speech, Bostic said, “If you want to achieve coordination, and you want us all to be able to agree on a course of action, that’s going to require a lot of communication and engagement, and we’re doing a lot of that.”

There were a handful of central bankers who thought a quarter-point cut in interest rates at the September meeting would make sense. They included Fed Governor Christopher Waller, one of the most influential members of the FOMC.

In a speech on Sept. 6, Waller made it clear that he favored a rate cut, but many interpreted his exact wording to mean he was advocating for a quarter-point move. In a CNBC interview following the meeting, he said that recent reports on consumer and producer prices that followed the speech ultimately led him to support a half-point rate cut.

FMW/Bloomberg

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