The Fed Should Cut Rates Now. Sadly, It Won’t.

Thursday’s wildly encouraging consumer price index report shows that the Federal Reserve should be cutting policy rates at its meeting later this month. Unfortunately, they’ll probably keep us waiting until September.

On the inflation front, just about everything seems to be going right. CPI fell 0.1% in June from the previous month and was up just 3% from the same period a year earlier. Primary rents and owners equivalent rent — the heavily weighted and inertial housing categories that have bedeviled the Fed for two years — are finally cooling on what looks to be a sustainable basis. And used car prices are still falling like stones.

The right move is to start lowering policy rates at the next decision on July 31. The Fed has a dual mandate to promote maximum employment and stable prices, and recent developments leave real interest rates tight at a time when unemployment is creeping higher and job growth is slowing. Labor market trouble can snowball quickly and unpredictably once it begins.

less housing

A rule developed by my Bloomberg Opinion colleague Claudia Sahm shows that historically, the economy is already in a recession once the three-month average of the unemployment rate rises at least a half percentage point above its low in the past 12 months. At present, it’s up 0.43 percentage point. The argument for cutting now is simple: High inflation appears to be vanquished, so why take risks with the employment side of the Fed’s mandate?

Still, I’m pretty confident that policymakers will wait anyway, as are traders. Fed funds futures now imply just an 8.5% probability of a cut in July but 90% odds of a reduction in September. Fed Chair Jerome Powell probably has a couple of reasons for waiting, but I’d like to offer some counterpoints to each.

First, policymakers feel that they’ve been headfaked by the data before and don’t want to jump to conclusions. As Powell put it in testimony this week before lawmakers, he’s looking for “greater confidence” that inflation is moving sustainably toward the central bank’s 2% goal. Powell’s right that risks remain, but policymaking is full of tradeoffs and it’s worth sacrificing a modicum of “confidence” to protect American jobs.