Hey, Fed! Why Are You So Restrictive?

Fed Chair Jerome Powell spoke at the Jackson Hole Economic Symposium last Friday and his speech was dovish as he confirmed a September 18 rate cut. Powell said, “The time has come for policy to adjust. The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks.”

While Powell was noncommittal on the size of a cut, the market liked the confirmation that policy is changing and will begin to be less restrictive. Powell explained that inflation has declined significantly, and his confidence has grown that inflation is headed on a path to 2%. He also said that upside risks to inflation have diminished, while downside risks to unemployment have increased. 

In fact, Powell mentioned the labor market 27 times in his short speech! Clearly, the Fed is more concerned with the labor market versus inflation now.

Yet, when we look back to 2019 before the pandemic, the labor market is much worse now than it was five years ago. So why is the Fed’s monetary policy so much more “restrictive” (i.e., interest rates are set at a sufficiently high level to put downward pressure on economic activity and inflation) today?

The chart below shows some important comparisons on inflation and the labor market between 2019 and 2024.

While it’s true that inflation is a bit higher now (2.6%) than it was in 2019 (1.8%), shelter costs have been a key contributor while most other components have been cooling off. Meanwhile, the unemployment rate and hiring rate are both clearly much worse today than in 2019.

In addition, the job openings to unemployment rate, which Powell cited, is also worse today. Yet, there’s an important caveat to this figure, as job openings today are overstated. Work from home was much less prevalent in 2019 before the pandemic, while today we’re more likely to see the same job posted in multiple states since people can more often work from anywhere.

Despite these differences in labor market conditions, the Fed Funds Rate averaged 2% in 2019 while today it is incredibly restrictive at 5.375%. Meanwhile, 10-year yields are 1-2% higher than in 2019, while mortgage rates are 2.5% higher today.

The bottom line is there is room for yields and rates to continue to move lower as the Fed begins cutting their benchmark Fed Funds Rate, albeit this will occur over time and not in a straight line. This will continue to provide wonderful homebuying and refinance opportunities and allow more people to benefit from wealth creation through homeownership.

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By The MBS Highway Team