Before we dive into the Federal Reserve’s dual mandate of maximum employment and price stability, let’s take a brief look at the history of the Federal Reserve and its responsibilities. The Federal Reserve is the U.S. central bank and was created by the Federal Reserve Act of 1913 to establish a monetary system that could effectively respond to stresses within the banking system. The Federal Reserve is comprised of seven Federal Reserve Board of Governors and the 12 Federal Reserve Banks. The seven Federal Reserve Board of Governors are nominated by the president of the United States and confirmed by the U.S. Senate. Subsequently, a Fed Chair and Vice Chair are appointed from the Federal Reserve Board of Governors – Jerome Powell and Philip N. Jefferson currently serve as Fed Chair and Vice Chair, respectively. The Federal Reserve performs five key functions which include (i) conducting the nation’s monetary policy, (ii) promoting financial system stability, (iii) supervising and regulating financial institutions, (iv) providing safe and efficient payment/settlement systems, and (v) promoting consumer protection and community development.
Monetary Policy:
So, where does the Fed’s dual mandate of maximum employment and price stability fall within these responsibilities? Within the monetary policy function. Monetary policy can be described as the actions the Federal Reserve takes to promote maximum employment and price stability as mandated by the U.S. Congress. Per the Federal Reserve website, maximum employment is the highest level of employment or lowest level of unemployment that the economy can sustain while maintaining a stable inflation rate, while price stability refers to stable and predictable prices for the goods and services we all purchase. When maximum employment and price stability are in balance, economists generally view the economy as being in equilibrium (Investopedia).
Tools to Use:
When necessary, there are a number of actions the Fed can take to promote its dual mandate. The most common practice is by raising or lowering its target range for the federal funds rate, which is an interest rate for overnight borrowing by banks. When the economy is overheating or inflation is unanchored (too high), the Federal Reserve often responds by raising interest rates. This action is known as “tightening” and raises the cost of borrowing for businesses and consumers and is intended to lead to a cooling of the economy. When the economy is lagging, or inflation is too low, the Federal Reverse can lower interest rates which is known as “easing.”Easing of monetary policy results in lower interest rates for businesses and consumers, which makes borrowing funds cheaper, and can help stimulate the economy leading to increased economic activity.
Interest rate decisions are driven by the Federal Open Market Committee (FOMC) which is comprised of the seven Federal Reserve Board of Governors, the Federal Reserve Bank of New York president, and four of the remaining 11 Federal Reserve Bank presidents (who serve one-year terms on a rotating basis). The FOMC uses a broad range of economic data to help guide their decision to raise or lower the federal funds rate.
In addition to raising or lowering its target range for the federal funds rate, the Fed can also pursue large-scale asset purchases (known as quantitative easing) or forward guidance which is a way for the Federal Reserve to guide expectations for future interest rate actions. For an example, quantitative easing took place during the 2008 financial crisis where the Federal Reserve purchased mortgage-backed securities to provide stability to the housing market (in the pursuit of rebalancing long-term interest rates) and to broadly provide liquidity to financial markets.
The Data:
Recent FOMC decisions have been populating headlines across financial news cycles. The FOMC’s decision to raise, lower, or maintain interest rates has the potential to impact financial markets depending on the data and the current macroeconomic backdrop. As mentioned above, the Fed uses a broad range of financial data to influence their decision on rates. Some primary reports include the Consumer Price Index (CPI), Producer Price Index (PPI), Personal Consumption Expenditures (PCE), and a number of employment and manufacturing reports.
So, what does the data say now? July Core CPI, which excludes volatile food and energy prices, came in as expected at +0.3% MoM while YoY Core CPI came in hotter than expected at 3.1%. July’s report showed the fastest pick up in Core CPI since January. Meanwhile July’s PPI, which tracks the prices wholesalers pay for goods, increased by +0.9% MoM and +3.3% from a year ago. July’s PPI increased at its fastest pace in three years. Both reports seem to indicate that inflation remains stickier than expected.
On the employment side of the mandate, the Fed actively watches weekly initial jobless claims (which track new unemployment filings), continuing claims (which track those receiving unemployment benefits), and the monthly non-farm payroll (NFP) report (which excludes agricultural, private household, and government payrolls). The initial jobless claims four-week moving average increased to 226,250. Continuing claims increased to 1.97 million. The weekly initial jobless and continuing claims reports remain within a sustainable range, moving horizontally and not showing signs of significant weakening in the labor market. However, July’s NFP report might be telling a different story. The NFP report showed an increase of 73,000 non-farm payrolls in July which came in below Bloomberg expectations for 105,000. Additionally, the May and June NFP reports were revised lower by a cumulative 258,000.
What’s Next?
How do the recent employment and inflation reports, among others, impact the Fed’s decision to move interest rates toward achieving their dual mandate? The road certainly remains cloudy. With a month remaining before the next FOMC meeting on September 16-17, investors looked to the Jackson Hole Symposium, and Fed Chair Powell’s remarks on August 22 for direction. Chairmen Powell’s remarks provided some direction: “The stability of the unemployment rate and other labor market measures allows us to proceed carefully as we consider changes to our policy stance. Nonetheless, with policy in restrictive territory, the baseline outlook and the shifting balance of risks may warrant adjusting our policy stance.”
Prior to Powell’s remarks, traders were pricing in a 73% chance of a rate cut for the September meeting, down from 90% a week earlier, according to Bloomberg’s World Interest Rate Probability data. Following his remarks, Bloomberg’s data showed that probability rising to 87%. Only time, and data, will tell.
Disclosures: This material is provided for informational and educational purposes only and should not be construed as investment, legal, accounting, or tax advice. It does not constitute a recommendation or solicitation to buy or sell any security or adopt any investment strategy. Certain statements herein reflect current expectations, estimates, or projections and are forward-looking in nature. Actual future outcomes may differ materially from those expressed or implied. No forecast, projection, or prediction should be relied upon as guaranteed. Economic and market data presented have been obtained from third-party sources believed to be reliable, including the Federal Reserve, U.S. Bureau of Labor Statistics, and Bloomberg, but accuracy and completeness are not guaranteed. All information is as of the date indicated and is subject to change without notice. References to Federal Reserve policy actions, interest rate expectations, or market probabilities are provided strictly as context for understanding economic conditions. Such commentary does not necessarily reflect the views of Howe & Rusling, and should not be interpreted as an indication of how markets or the Federal Reserve will behave in the future. Past performance of markets or economic measures is not indicative of future results. Monetary policy actions may have varied and unpredictable effects under different economic conditions. Howe & Rusling, Inc. is an SEC-registered investment adviser. Registration does not imply a certain level of skill or training.
