The one question on everyone’s mind about interest rates

By Bryan Mena, CNN

Washington (CNN) — After a grueling two years of high inflation and elevated interest rates, Americans are finally set for some relief: Federal Reserve Chair Jerome Powell on Friday offered his strongest affirmation yet that a rate cut is coming next month. But the size of that relief remains an open question.

Once the Fed begins to pare back its key interest rate, which influences borrowing costs across the economy, that will mark an important milestone in the central bank’s historic inflation fight. Price pressures are coming under control and America’s job market is running at a slower pace these days than in recent years. Data from the Labor Department released this week showed that job growth was much weaker in the 12 months that ended in March than previously reported. Unemployment also rose in July to its highest level since October 2021.

That’s precisely why the Fed is poised to cut interest rates in September for the first time since 2020. In addition to stabilizing prices, the Fed is also tasked by Congress to strive for maximum employment. While the US labor market remains healthy, economists aren’t sure if unemployment will hold steady or continue to climb.

Several Fed officials even considered the possibility of cutting interest rates at last month’s policy meeting, minutes released Wednesday showed, but instead opted to keep rates unchanged. A “vast majority” of them said they think it would be appropriate to roll out the first rate cut in September, if the economy evolves as expected.

As central bankers and prominent economists gather this week in Jackson Hole, Wyoming, for an annual symposium hosted by the Kansas City Fed, Powell delivered a strong signal to markets in his keynote speech Friday that the first rate cut is coming in about a month.

Wall Street has been antsy for the Fed to lower borrowing costs for a while now. Traders are currently seeing a strong chance of a jumbo, half-point rate cut in November, according to the futures market, after the Fed cuts in September for the first time.

Therein lies the one question on everyone’s mind: How aggressively will the Fed ultimately cut rates?

A high threshold for jumbo rate cuts

The Fed makes its decisions on interest rates consistent with what’s happening in the economy. For example, when inflation was running at multi-decade highs in the summer of 2022, the Fed hiked by a half point and three-quarters of a point at several meetings. During the Great Recession, the Fed frequently lowered rates by three-quarters of a point.

That means there is generally a high threshold for the Fed to take aggressive action, in either direction. And there is the risk of inflation reigniting if the Fed ends up stimulating the economy too much by cutting rates too soon or too aggressively. The US economy has consistently surprised to the upside these past few years.

“They’re still worried about another inflation bump, similar to the one we had in the beginning of the year,” Tani Fukui, an economist at MetLife Investment Management, told CNN.

Fed officials have mostly signaled that they’re finally ready to cut rates, but some have still expressed some hesitance. Atlanta Fed President Raphael Bostic said recently “it would be really bad if we started cutting rates and then had to turn around and raise them again.”

Powell has said recently that the risk of inflation staying elevated and the risk of the job market weakening more than expected “have come into better balance.” For the Fed to consider a large, half-point cut, central bankers would have to see mounting evidence of the job market faltering.

“Ultimately, the August jobs report released in early September will determine if the Fed cuts [by a half point] in September,” analysts at Citi said in a note to clients Thursday.

Wall Street is also now paying even closer attention to new applications for unemployment benefits, seen as a proxy for layoffs and arguably the earliest indicator of any shifts in the labor market, Ryan Sweet, chief US economist at Oxford Economics, said in a recent webinar for reporters. Sweet believes the Fed is likely to cut rates by just a quarter point next month.

There were 232,000 applications for jobless benefits last week, a slight increase of 4,000 from the prior week’s upwardly revised level, the Labor Department said Thursday. That’s still a historically low level, but claims have trended up in recent months. Continuing claims, which are filed by people who have received unemployment insurance for at least a week or more, also ticked up by 4,000 for the week ended August 10, to 1.863 million. Continuing claims are at their highest level since Thanksgiving week of 2021.

The government’s upcoming jobs report for August could possibly move the needle. If data show that employers added far fewer positions than expected and if unemployment edges even higher from its current level of 4.3%, then that could push the Fed to consider more aggressive action.

But, for now, there’s no emergency demanding the Fed cut rates aggressively next month, or any time later in the year. The Fed is known for being very predictable, so if the central bank at some point unveils a larger-than-expected rate cut, it could introduce volatility into financial markets and raise fears that there’s something wrong in the US economy.

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CNN’s Alicia Wallace contributed to this report.