"The Fed's megaphone" reminder: These three statements will "set the tone" for the September meeting!

Earlier this year, due to persistently high inflation rates, Federal Reserve officials faced setbacks. However, new risks in the labor market have helped reshape the basis for interest rate cuts at the Federal Reserve.

Nick Timiraos, a Wall Street Journal reporter known as the "Federal Reserve megaphone," stated that the biggest question before the Federal Reserve interest rate decision this Thursday is, how strongly will officials indicate their willingness to cut interest rates?

The market generally expects the Federal Reserve to maintain its benchmark short-term interest rate unchanged, staying in the range of 5.25% to 5.5%, the highest level in twenty years, while preparing for a rate cut at the next meeting in mid-September.

The Federal Reserve will release its policy statement at 2 a.m. Beijing time on Thursday, with Fed Chair Powell holding a press conference half an hour later. Here are the four most important questions before the decision:

What are the criteria for a rate cut in September?

The market expects officials to revise the policy statement to suggest a greater likelihood of a rate cut in September. The policy statement is being discussed in depth by the 12 voting members of the Federal Reserve's rate-setting committee.

Timiraos emphasized that seemingly insignificant changes in wording will be crucial for setting the stage for a rate cut in September, including:

The first paragraph of the statement will describe recent developments in inflation and the labor market;

The second paragraph will describe the risk balance between lowering inflation to the Fed's 2% target and maintaining a strong labor market;

The third paragraph will elaborate on the key language known as forward guidance, clarifying what officials need to look for before cutting rates.

Acknowledging recent improvements in inflation and a more balanced risk, as well as any changes to forward guidance, will set the stage for Powell's press conference. At the press conference, he can elaborate on how officials are handling the rate cut issue.

Some analysts believe that Powell will open the door wider for a rate cut in September without explicitly committing to any action. Former senior Fed advisor William English said, "If between now and September, the inflation news is okay, then they can say, 'Okay, we're confident things are on track, we're going to start cutting rates.'"

Why is the Federal Reserve getting closer to a rate cut?

Earlier this year, Federal Reserve officials were already considering rate cuts based on improved inflation. Surprisingly, strong inflation data in February and March thwarted these plans.

However, recently, inflation has been lower than expected. Additionally, the economy may be slowing more than expected, especially with the housing market stagnating and soft consumer spending among low-income consumers, which may make officials more convinced that higher rates are having the expected effects on economic activity and inflation.

Former Reserve Bank of India Governor Raghuram Rajan stated, "The Fed knows that their moves are right, some weaker parts of the economy are slowing down, although other parts remain strong, but people might say, 'If we really want a soft landing, we should start cutting rates now, because we've been in a restrictive mode for a while, even after the Fed cuts rates, policy may still remain restrictive

Why no rate cut in July?

Timiraos pointed out that some former Fed officials and private sector economists believe that all the arguments in favor of a rate cut in September, namely the improvement in inflation data and signs of slowing spending and hiring that increase unnecessary softening risks, are equally applicable at the July meeting, and the Fed should cut rates this Thursday.

Nevertheless, senior Fed officials have indicated that they are not yet fully convinced that the inflation rate is on a sustained path to the 2% target. Following the Fed's June meeting, Powell stated that the first rate cut would be a "significant decision" that requires "making the right decision".

Setting aside the pros and cons of a rate cut in July, most Fed officials have already indicated that it is not yet appropriate to cut rates. English, currently a professor at the Yale School of Management, stated, "So, if they cut rates on Thursday, it will look very panicky, and I think it's likely to be unhelpful."

What will happen after the first rate cut?

Timiraos believes that Powell is unlikely to look too far ahead at the press conference, but these considerations may be an important part of private discussions among officials this week, as once policymakers take the first rate cut, they will face more questions about when to cut rates again.

Since last year, Fed officials' quarterly economic forecasts have included a rate outlook indicating that once they take the first step, they may cut rates by about 25 basis points each quarter.

Fed officials will not release new forecasts this week, but they will in September, allowing them to show whether the dot plot from June is still a reasonable expectation. If the labor market weakens further between now and then, officials may initially act at consecutive meetings. The Fed will meet again in November and December. Richard Clarida, who served as Fed Vice Chairman from 2018 to 2022 and is currently a senior advisor at Pacific Investment Management Company, said:

"If they have enough confidence to act in September, they must also act in November and December."

Timiraos added that the Fed's rate cut prospects currently face an awkward complexity: the two-day policy meeting in November will begin on the day after the presidential election on November 5th. While the Fed has adjusted policy during elections in the past, officials are trying to maintain a non-political stance when making decisions. This will make their public communication clearer, more predictable, and more thoughtful.