Powell’s prepared remarks for his semiannual monetary policy testimony suggest that there is a very high probability of a 25-basis-point cut in July. (See our commentary for the full analysis of his prepared remarks.) His responses to questions from lawmakers on House (on Wednesday) and Senate (on Thursday) subcommittees were consistent with there being a high probability of a rate cut at the July meeting. Our baseline view remains that the July cut will be 25bps. We didn’t see Powell’s remarks as providing any information about whether a July cut is more likely to be 25 basis points or 50 basis points.
As we mentioned previously, the pivot to easing at the June FOMC meeting was not about the weak May jobs report. In his Q&A, when asked whether the strong June jobs report changed his views on the appropriateness of a near-term rate cut, he was surprisingly frank, beginning his response, “a straight answer to your question is no.” He then elaborated on how he perceived recent developments. Data abroad have been weak, “and that continues to weigh.” Manufacturing and trade investment are weak worldwide. The recent job report was “positive, and that’s great news.” He said we also “had other reasonably good news [domestically]. I would say U.S. data came in about as expected.” As expected, he didn’t see the agreement between the U.S. and China to resume trade talks as fundamentally changing his views. While it is a “constructive step, it doesn’t remove uncertainty we see as overall weighing on the outlook.” Summing up, the “bottom line is uncertainties around global growth and trade continue to weigh on the outlook. In addition, inflation continues to be muted and those things are still in place.”
Business investment was clearly his primary concern. He noted “it was very strong through ’17 and most of ’18” and “really slowed down.” He connected it specifically to trade policy uncertainty and the weakness in manufacturing in the U.S. and abroad. In contrast, he said, “This is a good place for the consumer part of the economy, and you see that in surveys, you see it in consumer spending.” He pointed to “good job creation,” “rising wages,” and “plentiful” jobs. To be completely clear, he elaborated, “The issue is more on the business side where you see business confidence and business investment weakening a bit.”
He also sounded quite aggressive on the issue of labor market slack. He repeatedly referred to the labor market as “tight,” but he objected to the notion that the current situation amounts to a “hot” labor market, which is important because it’s an implicit defense against the criticism that cutting rates would be inappropriate with the unemployment rate so low: “we don’t have any basis for calling this a hot labor market…3.7% is a low unemployment rate, but to call something hot you need to see some heat.” He pointed to moderate wage growth as supporting his argument, noting that 3% wage growth “barely covers productivity [growth], doesn’t even cover productivity increases and inflation, and not a high enough end wage to put any upward pressure on inflation.” Again and again, he made similar comments about the labor market. For example, he noted that, in addition to the current rate of wage growth not being elevated, the level of wages is “missing ten years of growth.” He drew on the idea that “a couple more years” of a strong labor market would be particularly beneficial to lower-income workers.
He acknowledged that “we really have learned that the economy can sustain much lower unemployment than we thought without troubling levels of inflation.” Echoing a point that Clarida has been making for some time, he said, “I think I would look at today’s level of unemployment as well within the range of potential estimates, of plausible estimates, of what the natural rate of unemployment is.” In fact, he sounded a lot like Clarida when he talked about both of the so-called stars: “I think we’re learning that the neutral interest rate is lower than we had thought and I think we’re learning that the natural rate of unemployment is lower than we thought so monetary policy hasn’t been as accommodative as we had thought.” It was a strong acknowledgment that policymakers would like to see monetary policy be slightly easier.
The concern about inflation being too low and inflation expectations slipping that were palpable in the minutes were also apparent in Powell’s testimony. He cited the difficulties that the BOJ and ECB have faced in fighting low inflation as a warning for what could happen in the U.S. if lower inflation is not dealt with promptly and decisively. It could create a vicious cycle of lower interest rates and less capacity to react: “We see that road is hard to get off of. We must fight at 2% to keep inflation up to 2% and use our tools to achieve that symmetrically. And we’re strongly committed to doing that.”
Powell was asked pointedly about his views on the potential size of a July cut and the prospect of a larger (50bps) cut. He didn’t give away anything. He simply repeated the mantra of data dependence. In the context of the material probability that the market is placing on a 50bps cut, one could interpret his lack of pushback against a larger cut as a hint that he might support one. He certainly left that option open, but we don’t see his remarks as indicating any particular support for that option. Our call remains that the cut will be only 25 basis points. A larger cut would signal more alarm and doesn’t seem consistent with what most FOMC participants are saying. Indeed, some policymakers are skeptical of the need for a cut at all, which also argues for a 25bp cut.
On a separate note, Williams spoke today, and his comments suggested he would also be on board for an easing in July. He seemed to share Powell’s general views. Williams warned, “the headline data mask a more nuanced economic picture.” Although consumption has been strong, “other signs point to slowing growth.” He shared Powell’s worry over softer investment and declines in manufacturing activity. He explicitly linked the risks to investment as partially emanating from abroad: “The U.S. economy is growing really nicely. The rest of the global economy is not quite at that place, and we’re seeing some signs of slowing, which is affecting these investment flows into the U.S.” Williams also called the employment data “mixed” because the unemployment rate is low but the trend in job growth has clearly slowed. As for inflation, he said “underlying” inflation is “below our 2 percent goal” and repeated the warning that persistently low inflation could spill over into lower inflation expectations, which in turn would erode the capacity of policymakers to ease. Williams also echoed the “sustaining the expansion” ethos: “Really what we want to do is extend this expansion, and have a monetary policy in the right place to do that.” Recent comments from Powell, Clarida, and Williams strongly suggest that they agree to a July rate cut.