Arguments against Immediate Fed Rate Cut

Source-This post on Arguments against Immediate Fed Rate Cut has been created based on the article “The Fed should not cut interest rates yet” published in “Business Standard” on 20 July 2024.

UPSC Syllabus-GS Paper-3- issues relating to Planning, Mobilization of Resources, Growth, Development and Employment.

Context- The article suggests caution for the Federal Reserve regarding immediate interest rate cuts, despite market expectations leaning in favor of them. Economic indicators advise restraint.

What is the rationale behind rate cut expectations?

1) Cooling inflation: There was no inflation in May, followed by deflation in June according to the CPI measure.

2) Rising unemployment -The unemployment rate has been rising since last summer, reaching 4.1%, up 70 basis points from its pandemic low. This pattern of incremental increases has prompted calls for the Fed to begin cutting interest rates.

What are the Arguments against Immediate Fed Rate Cut?

1) Inflation measurement discrepancies: The Fed uses the PCE price index, not the CPI. Core PCE inflation likely rose by 0.2% in June. Projected inflation for the remainder of 2024 is expected to be between 2.6% and 3%, which exceeds the Fed’s 2% target

2) Strong consumer demand factors: Low unemployment boosts earnings growth, with wages outpacing consumer prices for over a year. There are strong fixed-income flows and increased wealth from housing and stocks.

3) Economic growth indicators: June retail sales surpassed expectations. The Atlanta Fed’s GDPNow model forecasts 2.5% real economic growth in Q2, which could increase price pressures.

4) Labor Market Analysis – The labor market is showing signs of weakening but remains robust. Demand for labor continues to exceed supply. This trend is driving wage inflation, with average wages growing 3.9% year-over-year in June.

5) Monetary Policy Stance– Since November, financial conditions have improved with higher stock prices, lower long-term interest rates, and narrower credit spreads. This has reversed the financial tightening caused by the relatively high Fed policy rate.

Read More- The RBI Keeps interest rates unchanged

What should be the way forward?

1) Rising unemployment and underlying inflation below 3 per cent suggest that the Fed should start paying attention to both sides of its dual mandate.

2) The Fed should be ready to act, especially if the labor market worsens or if the next two PCE readings show inflation moving steadily toward the Fed’s target.

Question for practice

What are the Arguments against Immediate Fed Rate Cut?