By: Thomas Rizzo
Vol. 24 No. 9
The Peak of Contractionary Monetary Policy
Today represents a shift in monetary policy as the Fed pivots from contractionary to expansionary monetary policy. In this monetary policy cycle, in an attempt to fight inflation, the Fed has raised the benchmark rate 11 times, leaving it unchanged at 5.25% – 5.50% for over a year. The circumstances that ignited this aggressive rate cycle resulted from post pandemic headline inflation climbing to over 9.1% in June 2022. Through the rate hikes mentioned previously, inflation has cooled down to 2.5% as of August 2024, which is slightly higher than the policy target of 2.0%.
Another policy target of the Fed is to maintain maximum employment. Maximum employment can be looked at as either the highest level of employment or lowest level of unemployment that the economy can sustain while maintaining a stable inflation rate. Some indicators of shifts in the labor market that the Fed closely watches include nonfarm payrolls, which as of recently have rebounded after a slump over the past several months, but that are still significantly lower than a year ago.
With the battle against inflation appearing to be won, the Fed is shifting its focus to maintaining the balance between stable prices and maximum employment as the labor market begins to show signs of weakness.
The Future of Monetary Policy
A new expansionary monetary cycle has begun, and market participants are pricing in what that is going to look like for the remainder of the year. Given some of the latest market data, market participants are pricing in a 50 basis point cut in today’s meeting, then a 25 basis point cut for the November meeting, followed by another 50 basis point cut in the December meeting. This takes the benchmark rate down from the current 5.25% – 5.50% to 4.00% – 4.25% by the end of the year.
Key Takeaways:
- The Fed’s pivot from contractionary to expansionary monetary policy signals a significant shift as inflation cools down to 2.5%, close to the Fed’s 2.0% target.
- Market expectations suggest a 50 basis point cut today, followed by a 25 basis point cut in November and another 50 basis point cut for December.
- Market participants are pricing in the benchmark rate to settle at 4.00% – 4.25%, representing a 125 basis point drop from the current 5.25% – 5.50%.
- With inflation under control, the Fed’s focus shifts to balancing stable prices and employment as the labor market begins to show signs of weakness.