Focus on what the Fed cares about: Labor data
As I have discussed since late 2022, the Federal Reserve is more focused on labor data than the growth rate of inflation when determining how many rate cuts it can deliver for the economy. In his remarks at Wednesday’s press conference, Powell said that the labor market is strong and does not require rate cuts.
However, Powell also highlighted the challenges faced by unemployed Americans and the difficulty of getting a new job. Before Powell switched the game plan in 2022, making it about the labor market more than inflation, he noted he would like to see the Fed Funds rate mirror 3, 6 and 12-month PCE data. Well, if they were operating off those numbers, the Fed Funds rate would be close to 3% since this is the most recent data:
- 3-month annualized rate: 2.7%
- 6-month annualized rate: 2.6%
- April core PCE 12-month rate: 2.5%
- The headline PCE inflation report 12 months was at 2.1%
If tariffs lead to increased prices and inflation approaches 3% as the Federal Reserve has indicated, then, assuming this is a one-time price increase, lowering the Federal Funds rate to around 3.5% would still be above the Fed’s inflation target. This rate closely aligns with some people’s definition of a neutral policy.
If the Fed waits until the labor market weakens to take action, it may be seen as being slow to react again. Since the Fed often cites that their policy is moderately restrictive, they’re now issuing a note that they seem ok with the lack of hiring going on today. Remember that the Fed noted before the year started that if the unemployment rate starts rising above 4.2%, they would be concerned, but that concern doesn’t seem to be present today.
Between 2022 and 2024, the Fed had the flexibility to wait because the labor market wasn’t breaking. However, the room for maneuvering regarding labor conditions is no longer as broad. Job openings are down and job growth has slowed to the extent that Powell admits it is becoming difficult to find a job. Jobless claims, measured by a four-week moving average, have been rising to year-to-date highs and continuing claims are now at a three-year high.
The closer you get to neutral with an inflation target of 3%, the less catch-up the Fed might have to do if they wait to see the labor market getting weaker, as they did in 2024. Let’s not forget that two meetings ago, Jerome Powell openly admitted that they were late to cut rates, as the labor data was weaker than they had realized. They were playing catch-up to the data.
For the first time in many years, the labor data year-to-date is underperforming my forecast. I noted in my article about jobs Friday that Powell needs to see real labor damage to cut toward neutral policy. Now, with the 12-month growth rate of inflation being at 2.1%, you can see why I always focused on labor over inflation.
Conclusion
My advice to Trump is to focus the discussion about Fed rate cuts on the labor market rather than interest expenses. The Federal Reserve doesn’t prioritize interest rates in that way, and Americans may not resonate with that argument when it comes to budgeting.
Instead, Trump should emphasize Powell’s statement about the difficulty of finding jobs and highlight the Fed’s history of waiting too long to respond to labor data over the decades. This approach will frame the debate around the labor market and the challenges facing American households, which are more directly relevant to people’s daily lives than the issue of interest expenses.
For those in the real estate and mortgage industry, remember that 65%-75% of the movement in the 10-year yield and mortgage rates is driven by Fed policy, which is why Fed interest rate hikes and cuts matter.
The people who work at the Fed are human and like all human beings, they can feel the pressure if a proper, consistent message is being discussed. For me, Americans can relate more to the labor data than interest expense savings and the Fed will feel the pressure if the labor data gets weaker.