Federal Reserve Cuts Rates, Shifts Focus to Employment Amid Slowing Economy

In a significant policy shift, the Federal Reserve announced a reduction in interest rates, marking a transition in its policy focus from inflation to employment. The decision, described as a "risk management" move, comes as economic indicators suggest a slowing economy and a labor market that is cooling down. The Fed's latest economic projections indicate that the U.S. GDP growth for this year is expected to be around 1.6%, slightly higher than the previous estimate of 1.5%. For next year, the growth is projected to be 1.8%.

The labor market, which has been a key area of concern, shows signs of softening. The average monthly increase in non-farm jobs over the past three months has been around 29,000, significantly lower than the rate needed to maintain a stable unemployment rate. While the unemployment rate remains low, it has shown marginal increases, indicating rising downside risks to employment. Wage growth continues to moderate but remains slightly above inflation levels.

Inflation, although lower than its peak, remains above the Fed's 2% target. The Personal Consumption Expenditures (PCE) price index, a key measure of inflation, was around 2.7% for the 12 months ending in August. The core PCE, which excludes food and energy, was around 2.9%. The recent uptick in inflation is primarily due to a resurgence in goods prices, while service inflation continues to weaken. Short-term inflation expectations have been influenced by trade policy developments, but longer-term expectations remain anchored around 2%.

The Fed's policy path, as indicated by the dot plot, shows a gradual reduction in interest rates, with the median rate expected to be around 3.6% by the end of this year, 3.4% in 2026, and 3.1% in 2027. This suggests that further rate cuts are possible this year. The Fed also continues to reduce its balance sheet, a process that is seen as a technical adjustment rather than a significant tightening of monetary policy.

When asked about the rationale behind lowering rates while inflation remains high, the Fed emphasized that the decision is a risk management move. The labor market is showing signs of cooling, and the Fed needs to reflect this in its policy settings. The Fed also noted that while inflation risks have eased somewhat, the downside risks to employment have increased, necessitating a more balanced policy approach.

The Fed's stance on monetary policy has shifted from a significantly tight position earlier this year to a more neutral stance. This shift is driven by the changing risk dynamics, with employment risks becoming more balanced. The Fed also clarified that there is no broad support for a 50 basis point rate cut at this time, indicating a cautious approach to policy adjustments.

Regarding the impact of trade policies on inflation, the Fed noted that goods inflation has contributed around 1.2% to overall inflation, with a smaller impact on core PCE. The cost of tariffs is largely absorbed by importers and distributors, with a slower and smaller pass-through to consumers. However, the Fed remains vigilant and is prepared to take necessary actions if inflation shows unexpected increases.

The Fed's primary mandate remains achieving maximum employment and stable prices. While monitoring financial stability risks, the Fed does not see significant structural vulnerabilities at present. The Fed also emphasized its commitment to data-driven decision-making, ensuring that its policies are based on current economic conditions rather than past data.

In response to questions about the Fed's independence and governance, the Fed reiterated its commitment to its dual mandate of maximum employment and price stability. The Fed's decisions are based on strong, data-driven arguments, and its long-term independence is not in question. The Fed also declined to comment on specific legal cases involving its members.

The Fed acknowledged the challenges faced by young graduates and minority groups in the labor market. The combination of low dismissal rates and low hiring rates increases the risk of broader job losses, which is another reason for the Fed's balanced policy approach. Regarding the impact of artificial intelligence on the labor market, the Fed noted that while it could be a factor, the evidence and magnitude are not yet clear. In the housing sector, the Fed acknowledged that monetary policy has a natural impact through interest rates, but deeper supply issues require broader solutions beyond monetary policy.

The Fed's forward guidance, as indicated by the dot plot, shows that there is still room for further easing this year, but this does not represent a predetermined path. The Fed's policy is flexible and data-dependent, reflecting the complex interplay between its dual mandates of maximum employment and price stability. The Fed will continue to monitor economic data and adjust its policies accordingly to navigate the challenges ahead.