The Fed's interest rate cut cycle begins, but Powell's challenge is just beginning

Jerome Powell argued this week that the Federal Reserve did not "lag" at the beginning of the rate-cutting cycle. His main challenge in the coming months will be to maintain the coherence of this narrative if the job market continues to cool and the economy deteriorates. Powell said at a press conference, "We don't think we lagged, we think this was timely, but you can see it as a sign of our commitment not to fall behind." Some on Wall Street still have doubts, believing that the Fed's significant 50 basis point rate cut this week was an attempt to catch up with the curve, and that the future rate-cutting path may be too shallow. Gregory Daco, Chief Economist at EY, stated that the Fed is cutting rates in a "reactive" rather than proactive manner. He pointed out, "Powell acknowledged that if the Fed had seen the July employment data first, they might have cut rates in July." Data released two days after the July meeting showed an increase in the unemployment rate to 4.3%, raising concerns about the Fed waiting too long to act. Although the unemployment rate dropped to 4.2% in August, the same concerns may resurface if it rises again in the coming months. Daco said, "Fed policymakers must adopt a strong forward-looking framework and abandon the practice of relying on data, unfortunately, they have not done so yet." Fed officials predicted this week that the U.S. unemployment rate will rise to 4.4% this year and remain at that level next year. Another challenge Powell faces is that Wall Street expects more rate cuts in the future than Fed policymakers predict. This week, policymakers estimated two more rate cuts by the end of 2024, each 25 basis points, and four more cuts in 2025. Michael Feroli, Chief Economist at JP Morgan, said he still expects the rate cuts to be faster than the Fed consensus. Feroli expects that if the next two employment reports weaken further, there will be a 50 basis point cut at the next meeting in early November. Luke Tilley, Chief Economist at Wilmington Trust, said the Fed's predicted rate-cutting path is too slow for an economy with a normalized job market and inflation expected to reach the Fed's 2% target in the first quarter of 2025. Therefore, Tilley expects a 200 basis point cut next year (twice the Fed's forecast) and rates to fall to a neutral level that neither stimulates nor restrains growth by next fall. He said, "More importantly is the long-term path, and at this point, the Fed is still slightly behind, as the median forecast is only for a 100 basis point cut next year." Powell will also have to deal with signs of internal dissent on the rate-cutting path. The Fed's rate-setting committee is almost evenly split on the expected additional rate cuts this year, with seven policymakers supporting another 25 basis point cut by year-end, nine members supporting an additional 50 basis point cut, and two policymakers expecting no further cuts This path means that although some officials may support a 25 basis point rate cut this month, they choose to cut rates by 50 basis points to avoid further deterioration in the job market. Fed Governor Bowman even voted against the 50 basis point rate cut and instead supported a smaller 25 basis point cut. This is the first dissenting vote at the Fed since 2005. Dako said, "Fed Chairman Powell is now considered to have significant influence on the Federal Open Market Committee, as he successfully convinced most officials that an early rate cut is optimal, but at the cost of decision-makers being more resistant to rapid rate cuts in the next two policy meetings."