The Fed has just hinted at the first cut in four years

The Federal Reserve voted to leave interest rates unchanged on July 31 but made slight tweaks to its policy statement that could lead to a September rate cut.

In its official policy statement, the Fed described inflation as “somewhat elevated,” a notable change in tone from past statements.

Although headline inflation is at 3%, the Fed’s preferred measure of consumer prices—the core PCE index—reached a 2.6% annual rate in June.

By acknowledging progress on inflation, officials were able to shift to a more balanced approach to tackling interest rates.

The statement said, “The committee is attentive to both sides of its dual mandate,” referring to the central bank’s commitment to controlling inflation and promoting full employment.

“I think this was the right incremental move,” Bank of America managing director Michael Gapen told Bloomberg. “I think the Fed feels that it’s in a sweet spot right now, that the data is moving in its direction, so it’s getting closer.”

The shift to a more balanced mandate couldn’t have come at a better time, with many economists sounding the alarm on a slowing economy that could disrupt hiring and boost unemployment.

The Fed’s soft pivot comes at the right time

For the past two years, the Fed has been hyper-focused on its inflation mandate, which economists said was a big obstacle to lowering interest rates.

With inflation inching closer to the central bank’s 2% target, policymakers can now shift their focus back to the labor market, which is showing signs of stress.

Over the past year, the national unemployment rate has been creeping higher, rising from a low of 3.4% to the current rate of 4.1%. While layoffs remain low, so do new jobs.

According to the Bureau of Labor Statistics, in June, there were 1.2 job openings for every jobless worker—down from a high of 2 in early 2022.

A softening job market has also capped wage growth. Last quarter, private-sector salaries grew at the slowest pace since 2020, according to the latest BLS data.

For these reasons, Queens College president Mohamed El-Erian believes the Fed needs to cut interest rates in September.

In his view, failing to do so could cause “undue damage to the economy” and force the central bank to make bigger rate cuts in the future to avoid a recession.

Although Wall Street cheered the latest GDP report showing stronger-than-expected growth in the second quarter, economist David Rosenberg warned that it masks bigger issues in the economy.

Rosenberg said that roughly 80% of the economy’s 2.8% annualized growth rate came from just three sources: “savings rate drawdown, the beloved government sector, and inventory building.”

Like El-Erian, Rosenberg believes the Fed should begin cutting interest rates sooner rather than later. He recently told CNBC that the central bank should have started cutting rates in July.