Goldman Sachs’ economics chief argues for rate cut in July
There was brief interest Monday morning in the idea that the Federal Reserve might cut interest rates at its July meeting. Federal Reserve Chairman Jerome Powell effectively rejected the idea. Monday afternoon.
Jan Hatzius, chief economist and head of global investment research at Goldman Sachs, released a note on Monday morning, “Solid evidence” They called for a rate cut at their meeting on July 30-31. The basic argument was that if the Fed was already convinced that they should cut rates in September, why wait?
The details are a bit more interesting. Hatzius claims:
First, if the need for a rate cut is so clear, why wait another seven weeks to do so? Second, a September cut could be difficult to explain, given the volatility of monthly inflation and the risk of a temporary re-acceleration; starting cuts in July would avoid that risk. Third, the FOMC has an undeniable incentive (even if it will never admit it) to avoid starting cuts in the final two months of a presidential campaign. This does not mean that the Committee cannot cut rates in September, just that July would be preferable.
The market is not expecting a rate cut in July, so at least I commend Hatzius for his willingness to step outside the consensus. As of Monday afternoon, the federal funds swap market was suggesting just under 7% chance of a rate cut in July. In contrast, the chance of a September rate cut is currently at 98%.
Serious flaws in Hatzius’s argument
But there are some big things where Hatzius gets it wrong. Most importantly, The need for cuts is unclearThe Fed has said that it would be appropriate to cut interest rates when it is confident that inflation can sustainably fall to 2% — in other words, when it is confident that it can lower interest rates to keep inflation at its 2% target.
In the first three months of this year, inflation has risen sharply after falling considerably last year. The Fed was taken by surprise. And officials were forced to backtrack on their message that they would begin cutting rates early this year. Remember, the Fed’s announcement had the market expecting five or six rate cuts in January or even March of this year. The Fed actually pretty explicitly rejected that view, explaining that they needed several months of data beyond March before they felt comfortable cutting rates.
of The timing of the initial Fed bounce is importantThe Fed began warning in January that expectations of a rate cut in the first quarter of this year were wrong, before data showed high inflation. At that point, the Fed’s inflation gauge, the annualized personal consumption expenditures (PCE) price index, had been near or below its 2% annualized target in five of the previous six months, with a high of 4% in September being the only exception.
Inflation rose significantly in January and remained above the 2% target for the next three months. So far this year, there has been one month in which PCE data has been below target. It is true that PCE inflation is likely to be more moderate once June data is released, but This is just two months of good news after four months of bad news.This is not enough data to give the Fed confidence that further rate hikes are not expected.
Hatzius knows this is possible; in fact, he describes it as possible. “A temporary re-acceleration.“ But the Fed is unlikely to see it that way. Instead, it’s more likely to see the reaccelerating inflation as a sign that it’s not sure it’s on the way to 2%. A much more likely interpretation is that inflation is in danger of getting stuck between 2.5% and 3%.
The Fed doesn’t want to get ahead of the economic recovery, especially in an election year, and especially now in an election year. Republicans likely to win a landslide victory in NovemberThey will control the Senate and the White House and retain control of the House of Representatives. Cuts that appear reckless would encourage Republican efforts to limit the Fed’s discretion, perhaps by changing its dual mission or passing legislation requiring the Fed to adhere to a rules-based interest rate policy. Cuts that appear reckless and political would guarantee legislation to limit the Fed would come from a Republican-controlled Congress.
Are the July cuts less politically harmful than the September cuts? Perhaps. But only slightly. And this is another major flaw in Hatzius’ argument. Biden is trailing in the polls and support for Trump is solidifying in the wake of this weekend’s horrific assassination attempt. The Fed’s rate cut this month will be seen by many as an attempt to bail out the current administration..
Powell followed his scripted remarks on Monday, saying the Federal Open Market Committee was taking things one meeting at a time and needed to gain more confidence before cutting interest rates. This means July will be excluded. A rate cut in September is also unlikely, barring an unexpected economic crisis.
