Joe Biden’s upbeat forecasts for the US economy have been validated by the Federal Reserve’s signal that it will consider interest rate cuts next year, delivering respite to American households through lower borrowing costs after two years of high inflation.
For months, Biden administration officials have been betting on a “soft landing” — one in which inflation would decline without any big rise in unemployment or a recession — as a fundamental feature of its economic record heading into the 2024 presidential election.
That expectation was validated by the US central bank this week, as it shifted towards a more dovish posture. The Fed indicated that its cycle of monetary tightening, which began in early 2022 to fight rapidly building inflation, had most likely ended, as officials forecast that its benchmark interest rate would be brought down by 0.75 percentage points next year from its current range of 5.25 per cent to 5.5 per cent.
The Biden White House has vowed to respect the Fed’s independence, and it rarely comments on monetary policy. But earlier this month on a visit to Las Vegas, the president said he was “not encouraging the Fed to raise rates” — as he praised the “sweet spot” reached by the US economy with steady jobs growth, rising wages and lower inflation.
On Friday, Lael Brainard, the director of the National Economic Council at the White House, said “recent data certainly give us more evidence that the width of the runway for a soft landing has gotten much bigger”.
She also pointed to “a much more positive view about what the economy is likely to look like over the course of the next year” in financial markets. “That is bringing down mortgage rates in a way that we also really welcome. We know housing affordability continues to be a squeeze for so many Americans,” Brainard said.
Since the Fed’s meeting, US government bond yields have touched multi-month lows, with the 10-year Treasury note, which serves as a global benchmark, trading below 4 per cent for the first time since August.
The prospect of the Fed shifting to lower rates will not only help potential homeowners and the housing market, but could ease costs across the economy, including for business investments.
Jennifer Harris, a former Biden White House economic official, said it was vital for rates to come down for the huge manufacturing incentives enacted over the past years to be completed.
“The rest of the economy could well muddle through on ‘higher for longer’, but that is not true for the delicate set of investments that are incredibly capital intensive that we just passed historic legislation to stand up.” Harris would like to see the Fed cut rates at an even faster rate than projected by its officials this week.
The trajectory of the economy is important for Biden on the cusp of an election year. The better outlook from the Fed has also chimed with a record high in the Dow Jones Industrial Average stock index, which the Biden campaign has been touting.
While the vote will be in November, perceptions of the economy are often cemented earlier in the year, and the president is trying to reverse dismally low approval ratings on his handling of the economy.
In his latest press conference this week, Jay Powell, the Fed chair, said politics would not be a factor in the central bank’s thinking.
“We don’t think about political events. We don’t think about politics,” he said. “We’ll do the things that we think are right for the economy when we think [it] is the right time. That’s what we always do.”
The Fed’s turn towards essentially calling the peak in interest rates and beginning to entertain rate cuts stemmed primarily from officials’ shifting stance on the inflation outlook. According to this week’s projections, a majority now expect price pressures to ease more rapidly in 2024 and 2025 than just a couple months’ prior before reaching a level consistent with the central bank’s longstanding 2 per cent target the year after that.
At the same time, officials forecast the economy will continue to grow over 1 per cent in 2024 and 2025, with a very minimal uptick in the unemployment rate to 4.1 per cent. It stands at 3.7 per cent.
But in a telling sign, Powell made clear that safeguarding the soft landing that he and other officials have been trying to engineer was also an important consideration for officials.
“We’re aware of the risk that we would hang on too long,” he said. “We know that that’s a risk, and we’re very focused on not making that mistake.”
Yelena Shulyatyeva, senior US economist at BNP Paribas, said she expected the Fed to be guided by the inflation data, which could mean it holds off until May to begin lowering borrowing costs. Over the course of 2024, she forecasts the federal funds rate to decline by 1.5 percentage points before falling below 3 per cent by the end of 2025.
“They will not hesitate to cut faster if they see a significant deterioration in economic activity,” Shulyatyeva said.
Andrew Patterson, senior international economist at Vanguard, said one risk might be if the Fed proceeds to slash interest rates before inflation was well and truly vanquished.
“If they do end up cutting pre-emptively . . . they’re risking a reacceleration in inflation and then an eventual recession as a result of that because they are going to have to hike [again],” he said.