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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is Professor of Economics at the University of California, Berkeley
Global stock markets are in turmoil, jolted by a disappointing US jobs report last Friday. Speculation is rife, as always in the wake of such moves, that the Federal Reserve will cut interest rates.
The Federal Open Market Committee has a few different options ahead.
It could decide on an emergency interest rate reduction prior to its regularly scheduled September meeting, mirroring its reaction to the Covid crisis in March 2020. Or it could wait until September but cut rates by more than the 25 basis points signalled previously. Most likely, however, it could simply stay the course.
First, it is important to remember, as the Fed surely does, that the stock market is not the economy.
The Fed responds to inflation and growth, not the level or volatility of share prices. It reacts to the stock market only when volatility threatens financial stability. For the moment, there is no evidence that this is the case.
Nor is there evidence of an incipient recession. The stock market has predicted nine of the past five recessions, as the Nobel laureate Paul Samuelson famously observed. It is not a reliable signal of a looming downturn.
Moreover, one lousy jobs report does not make a trend. The jobs numbers were good as recently as June. Although unemployment ticked up by two-tenths of a percentage point in July, the economy still added 114,000 jobs. More workers entering the labour force is not a bad thing.
Above all, it is important to bear in mind, as the Fed also does, that the jobs numbers are noisy.
The July numbers were affected by disturbances caused by Hurricane Beryl. They can also be subject to significant revisions once more data are in hand. The Fed is likely to wait on these before drawing definitive conclusions.
While last Friday’s jobs report may have triggered the markets’ reaction, other factors contributed to unsettling investors.
Air is leaking out of the artificial intelligence bubble, as investors question whether a burst of generative productivity growth is really in the cards. It is no coincidence that tech stocks like Nvidia and Samsung led markets down earlier this week. Then there is the unresolved crisis in Gaza and the West Bank, and a looming war between Israel and Iran that threatens to draw in other countries.
Some will say that disappointment over AI returns and worries about the Middle East are reasons to think that spending growth will slow and the US economy will slip into recession, giving the Fed extra motivation to reduce interest rates.
But again, FOMC members are likely to wait and see. They understand that an emergency inter-meeting cut, or even a larger than expected 50 basis-point reduction in September, is more likely to panic than settle the markets, which will infer that the Fed shares or even exceeds their pessimism.
Finally, Fed chair Jay Powell et al understand that the US is in the throes of a presidential campaign. Donald Trump may be a self-avowed low interest rate man, but he is certain to complain that anything the Fed does to goose the economy now is an effort to cook the election in favour of Kamala Harris and the Democrats.
Trump understands that the incumbent administration is seen, rightly or wrongly, as owning the economy. The worse the economy and the markets perform between now and November, the better for the challenger.
The Fed is apolitical. It does not respond to pressure from politicians, as Powell has taken great pains to emphasise. That said, the central bank independence that is a prerequisite for remaining apolitical is not absolute. Preserving such independence as the Fed enjoys requires not attracting undue political attention and criticism, now or in the future.
This in turn means that the Fed is likely to move cautiously and incrementally. Its guidance has led the markets to expect a 25 basis point interest rate cut in September, followed perhaps by a couple of additional 25 basis point cuts after the election. It is unlikely to disappoint these expectations one way or the other.
Historians may conclude that the Powell Fed was too slow to loosen in response to a weakening economy in 2024, just as it was too slow to tighten in response to inflation in late 2021.
Time and incoming data will tell. All we know for certain is that Powell will have plenty of explaining to do when he saddles up in Jackson Hole for the Kansas City Fed’s annual jamboree a couple of weeks from now.