by Howard Schneider

JACKSON HOLE, WYOMING (Reuters) – After two years of fighting inflation, the Federal Reserve is returning its focus to the other side of its dual mandate: full employment.

The speech Friday by the chairman of the institution, Jerome Powell, delivered during the Jackson Hole symposium, opened the door to rate cuts and suggests that monetary policy will have to adapt to a weakening of employment that is already underway.

However, the main question is not the Fed’s rate cuts, but the diagnosis that this weakening allows us to make of the American economy: is it stabilizing under the effect of the restrictive monetary policy, or has it already entered recession?

The answer will be provided by the upcoming monthly employment reports and will be essential to the calibration of the Fed’s next rate cuts, which seeks to avoid “a more pronounced slowdown in labor market conditions,” according to Jerome Powell.

“We are not seeking or desiring further cooling of conditions,” Powell said, suggesting that the current unemployment rate, 4.3%, is where the Fed would seek to preserve, given that “conditions in labor markets are less tight than before the pandemic.”

Unemployment was at 4.1% when Jerome Powell became Fed chairman in 2018, and hit a low of 3.5% in 2019 without worrying about inflation. Powell had said he hoped to return to those conditions after the Covid-19 pandemic.

The Fed’s policy rate is currently at 5.25%-5.5%, well above the long-term neutral rate of 2.8%. With inflation slowing toward its 2% target, the pace of monetary easing will depend on how quickly labor markets cool.

“These markets are slowing, but will they stabilize at these levels (…) or slow further?” asked Nela Richardson, chief economist at the ADP Research Institute, during Jerome Powell’s speech.

The economist shares the view of many observers and members of the Fed’s monetary policy board, who believe that activity remains solid and is simply returning to its long-term trends, after the upheaval linked to the pandemic. However, concerns about employment are intensifying.

TILT

The Fed’s rhetoric has evolved this year, because while the central bank was able to raise rates quickly without a significant impact on employment, the situation is no longer the same and the subject will be at the heart of the meeting on September 17 and 18.

Until January, the central bank’s policy statements had said officials were “very attentive” to inflation risks. In January, the passage was changed to emphasize that “risks from both sides of the mandate were now more balanced.”

In June, these risks were “better balanced,” while officials became “attentive” to inflation and labor markets in July.

These changes were made even more visible by remarks by Jerome Powell on Friday, with the Fed chairman saying that “the balance of risks to our dual mandate has changed” and that policymakers “will do everything possible to ensure a strong labor market.”

The September meeting will be a test of these commitments.

Fed policymakers’ rate projections, or “dot plots,” will be updated in September. This chart was updated in June, when the central bank projected a steady 4% unemployment rate, was still worried about persistent inflation and expected just one rate cut this year, of 25 basis points.

The change in tone is “alarming” and shows that the Fed has “waited too long” to cut rates, according to Ian Shepherdson, chief economist at Pantheon Macroeconomics.

Apollo Global Management chief economist Torsten Slok, on the other hand, believes that precipitous cuts could revive inflation, as layoffs remain low.

UNCERTAINTY

The Fed shares economists’ uncertainty.

True, July’s job growth of 114,000 was below the post-pandemic average, but it was in line with the pre-2020 trend.

The number of job openings per unemployed person, another important indicator, fell from a record two to one to 1.2 to one, again comparable to pre-pandemic trends.

Jerome Powell also qualified the rise in the unemployment rate on Friday, which he said was linked to an increase in the number of workers and fewer hires, rather than job losses.

“There are good reasons to believe in a return of inflation to 2% and solid labor markets,” he noted.

Susan Collins, president of the Boston Fed, said she sensed “resilience” in labor markets, adding she saw “evidence that (unemployment) is flatlining” rather than “surging.”

Conversely, Fed board member Adriana Kugler believes that the number of job openings per unemployed person is a poorly measured indicator, with job openings perhaps being overestimated while different measures of unemployment give a different ratio.

The trained economist estimates that the ratio is as high as 1.1, and is perhaps less than 1.

With other measures of unemployment, such as those including workers who have given up looking for work, “it would be possible to have a very different picture” of labor markets, she concludes.

(Report by Howard Schneider, by Corentin Chappron, edited by Sophie Louet)

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