The Fed is sounding the alarm on unemployment

Chicago Federal Reserve Bank President Austan Goolsbee no longer thinks inflation is the biggest risk facing the U.S. economy.

In an interview with Bloomberg News, the central banker said he’s “getting more concerned about the employment side of the [Fed’s] mandate.”

His comments came in response to the unexpected surge in the unemployment rate, which reached 4.3% in July—the highest in nearly three years.

Goolsbee said the uptick in unemployment could be “an indicator that we’re not settling down at steady-state levels,” but moving toward something that is “worse” in the short run.

“If that starts to happen, then our emphasis has to be significantly more on the employment side of the mandate,” he explained.

Goolsbee is referring to the Fed’s dual mandate of controlling inflation and supporting full employment.

If policymakers are really becoming more concerned about the employment side of the mandate, then they’re more likely to cut interest rates sooner.

Goolsbee's comments carry a lot of weight because he is an alternate member of this year’s Federal Open Market Committee (FOMC) at a time when the central bank faces scrutiny over its decision-making process.

One way or another, the FOMC is expected to act decisively at its upcoming policy meeting in September.

How big of a rate cut?

Economists and investors are nearly 100% confident that the Fed will cut interest rates on Sept. 18. The only question is whether it will be a standard quarter-point cut or a bigger adjustment.

Many leading economists, including Wharton School professor Jeremy Siegel, believe the central bank should resort to a more substantial rate cut than a quarter-point reduction.

In their view, the Fed will drag the economy into a recession if it doesn’t act decisively.

After the dismal July employment report, banks like JPMorgan Chase and Citigroup said they expect the Fed to lower rates by 0.5% at its September meeting.

However, not everyone is convinced that Jerome Powell’s Fed will drift away from the norm. According to a recent Bloomberg survey, nearly 80% of respondents expect a 0.25% rate cut in September.

The good news is that policymakers can find justification in either move.

A small rate cut would reaffirm the Fed’s “trust, but verify” approach to monetary policy. A larger cut would show that the central bank is moving to forestall a recession before it becomes more likely.

In the meantime, policymakers are celebrating slowing inflation since the second quarter.

Key measures of producer and consumer prices weakened more than expected in July, signaling that the Fed was on track to meet its inflation objectives.

The Producer Price Index (PPI) fell to an annual rate of 2.2% in July, down from June’s 2.7% rate. Meanwhile, the Consumer Price Index (CPI) dropped to 2.9% in July, the smallest increase in more than three years.