FOMC Boldly Cuts: One Member Objects

FORECASTS & TRENDS E-LETTER
By Henry Rohlfs
October 1, 2024

IN THIS ISSUE:

The Reasoning Behind Dissent
How Consumer Interest Rates Affected
Quantitative Tightening Continues
The Bottom Line

The biggest economic news of late has to be the Federal Reserve’s interest rate cut on September 18. The Federal Open Market Committee (FOMC) boldly decreased its target interest rate range by 0.5 percent to 4.75% - 5%. This is the first rate cut since the early days of the Covid pandemic in 2020.

In their post-meeting statement, the FOMC wrote, “The Committee has gained greater confidence that inflation is moving sustainably toward 2 percent, and judges that the risks to achieving its employment and inflation goals are roughly in balance.”

But important to note was the final vote on the rate cut was 11-1, with Federal Reserve Governor Michelle Bowman supporting a 25-basis point move. Bowman’s dissent was the first by a Fed governor since 2005.

Today we will examine the reasoning behind Governor Bowman’s firm stance and some reasons why the Fed needs to think again regarding further “jumbo rate cuts.”

The Reasoning Behind Dissent

On September 26, Fed Governor Michelle Bowman shared her views on the U.S. economy and monetary policy to the Mid-Size Bank Coalition of America Board of Directors Workshop in Dallas, Texas. She made it clear that she agreed with the FOMC’s assessment that progress had been made to lower inflation and cool the labor market. She agreed it was time for the Committee to cut interest rates, although not at the 50-basis point level supported by other members.

She made several observations on current economic conditions that formed her conviction that a 25-basis point cut was in order.

Prices are still high. “Prices remain much higher than before the pandemic, which continues to weigh on consumer sentiment.” This has “an outsized effect on lower- and moderate-income households…” Consumer discretionary spending has noticeably decreased indicating households still feel the pinch of inflation in their pocketbooks.

Unemployment is still historically low. The unemployment rate remains at 4.2%, below what the Congressional Budget Office considers to be full employment. The rise in the unemployment rate over the past year is due to an increase in the labor participation rate, which is the percentage of the working age population that is either employed or looking for work. Although the time to find a job has lengthened, more people joining the workforce is a positive sign for the economy.

The economy remains strong. Although economic growth has moderated this year, private domestic final purchases (PDFP), a measure of the goods U.S. residents purchase, is increasing. This suggests that economic growth is stronger than recent GDP estimates indicate.

She also believes that a 0.5 percent rate cut could be interpreted as a sign the FOMC “sees some fragility or greater downside risk to the economy.” A 25-basis point cut would instead reinforce the Committee’s belief that the economy remained strong while progress was being made to curb inflation.

Core inflation is still above 2%. The core value of Personal Consumption Expenditures price index, the Fed’s preferred measure of inflation, is at 2.7% as of August 2024. This measure is up from 2.6% in July.

Governor Bowman noted that large amounts of cash reserves are still on the sidelines waiting to be deployed when interest rates fall.

“Bringing the policy rate down too quickly carries the risk of unleashing that pent-up demand. A more measured approach would also avoid unnecessarily stoking demand and potentially reigniting inflationary pressures,” she said.

How Consumer Interest Rates Affected

The question consumers now ask is how the Fed’s rate cut will affect the interest rates they see. This would primarily be seen in credit card interest rates and the cost of home mortgage borrowing.

There has been some easing in credit card rates a few weeks ago. However, the national average APR is still at a whopping 20.78%. The average new credit card rate is 24.92%. Total credit card debt remains at record levels, over $1.14 trillion. Much like inflation rates, retail borrowing rates shoot up like a rocket but come back down slowly.

Graph showing rising credit card balances since 2008

The impact of the Fed’s rate reduction has already been factored into current mortgage rates. Mortgage interest rates have been decreasing since August and now sit at an average of 6.15% according to Bankrate.com.

Of course, if mortgage interest rates continue their downward trend and spike home purchases, this could spur more home price inflation that would offset the interest savings.

Quantitative Tightening Continues

We must also remember that in addition to approving a rate cut, the Fed continues to reduce the size of its bond holdings. Quantitative tightening has brought the Fed’s balance sheet down to $7.2 trillion, a reduction of about $1.7 trillion from its peak.

Starting in March 2022, the Fed began reducing its bond holdings. However, the Fed has slowed its balance sheet runoff this year.

Fed policy now allows up to $50 billion a month in maturing Treasurys and mortgage-backed securities to roll off each month. This effectively helps to contract the economy by reducing the money supply, discouraging borrowing and slowing growth.

In June, the Fed adjusted its policy, slowing the reduction in its Treasury holdings from $60 billion per month to $25 billion per month. The Fed continues to trim its holdings of mortgage-backed securities by $25 billion per month.

The Bottom Line

I agree with Governor Bowman that a 0.25% decrease in the Fed funds rate would have been more appropriate. Inflation remains the primary concern of U.S. households. Unemployment remains at near historic lows. A slower reduction in interest rates would be more appropriate.

If the Federal Reserve hopes to achieve the economic soft landing it seeks, caution must be the operative word in policy changes.

All the best,