The Fed is ready to cut rates at a moment's notice if needed

Although the Fed has penciled in just one rate cut in 2024, several members of its policy-setting board say they need to be prepared to shift course at a moment’s notice.

According to the minutes of the Fed’s June 11-12 policy meeting, where officials voted to leave interest rates unchanged, “A number of participants remarked that monetary policy should be ready to respond to economic weakness.”

Officials were especially concerned about sudden changes to the labor market, as a “further weakening of demand may now generate a larger unemployment response than in the past,” the minutes read.

If that happens, the Fed’s preferred “soft landing” could derail into something much worse, leading to a sharp rise in unemployment and a recession.

The Fed wants to avoid that at all costs.

For now, officials seem confident that the economy is on a “disinflationary path” that shouldn’t lead to a spike in joblessness. But economists warn that could change very quickly.

A delicate balancing act

As Fed Chair Jerome Powell recently observed, the U.S. economy is beginning to moderate, with GDP growth falling back to around 2% and unemployment inching higher to 4%.

While this should help the Fed put a cap on inflation, “at some point, you’re going to want to stop the slowdown from slowing further,” said Jonathan Pingle, chief U.S. economist at UBS.

Rubeela Farooqi, chief U.S. economist at High Frequency Economics, agrees that preventing a deeper slowdown should be one of the Fed’s top priorities.

“From a policy perspective, the Fed’s challenge going forward will be to keep rates at a level that not only helps keep inflation in check but also prevents unnecessary damage to the labor market,” Farooqi said.

Other experts believe the Fed has already lost the plot by not cutting interest rates. In their view, the economy is slowing much faster than the central bank expected, and policymakers should get ahead of the problem.

Queens’ College president Mohamed El-Erian is in that camp and has repeatedly argued that a slowing economy “has few buffers.” He thinks a “forward-looking Fed” would have already begun the easing process.

Bloomberg editor Edward Harrison has also criticized the Fed for underestimating the threat of a recession. In his view, putting so much emphasis on the current employment rate is a mistake.

“[T]he unemployment rate is always at its lowest right before a recession,” Harrison said.

He then added that recessions “aren’t about how low the unemployment rate is. It’s about how much things unravel such that people start cutting back on spending.”