Federal Reserve Chairman Jerome Powell laid out the groundwork for the next phase of monetary policy in his speech last Friday. He indicated that the Fed is ready to lower interest rates as inflation moves closer to the central bank’s 2% target and the labour market shows signs of cooling. Powell also expressed confidence that the Fed could achieve the rare feat of a soft landing – reducing inflation without triggering a recession.
The emphasis in Powell’s speech shifted from inflation to the labour market. Although recent data has shown a weak jobs market, there was no significant concern about an imminent recession or a wave of job losses. Instead, the focus was on the diminished threat of wage growth keeping inflation too high.
Powell noted that “the time has come for policy to adjust,” but the market is still leaning to a 25-basis point cut in September. While there are some observers who think that the Fed could opt for a 50 basis-point cut, this remains a minority view. It will be crucial for the Fed to clearly outline its monetary policy path in the coming year to reduce market volatility by shaping investor expectations.
If the Fed’s neutral rate, which neither stimulates nor restrains economic activity, is between 3 percent and 3.5 percent, it should take three to four quarters to reach this target, assuming no significant policy surprises. Market observers should keep in mind that the fiscal path following the presidential election in November could introduce varying inflationary pressures, potentially causing the Fed to slow down or reverse its policy direction.
Powell wasn’t the only central banker to signal a downward trend in interest rates. Bank of England Governor Andrew Bailey stated that while it’s “too early to declare victory” over inflation, the risks of persistent price pressures appear to be receding. The UK central bank lowered its benchmark interest rate earlier this month, and Bailey’s comments suggest he’s growing more confident about further rate cuts. Similarly, members of the European Central Bank’s Governing Council present at the conference expressed support for another interest rate reduction next month.
Despite the global trend toward easing rates, this is unlikely to change the Bank of Canada’s perspective on domestic monetary policy. Global economic activity and its implications for the Canadian macro economy will be more significant factors. However, easing global financial conditions, particularly falling interest rates, will benefit Canadian mortgage borrowers. Since our bond market is heavily influenced by US rate developments, any easing in US rates typically impacts our yield curve, which is positive news for borrowers. Nevertheless, even with the rate cuts, roughly half of borrowers will experience “sticker shock” when renewing their mortgages over the next two years, since mortgages originated in 2020 and 2021 benefitted from historically low interest rates.
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