5 factors to consider as the Federal Reserve considers lowering interest rates

The Federal Reserve’s Free Open Market Committee (FOMC) will meet next week to determine whether or not the Federal Funds Rate should be adjusted. After quickly raising rates to combat high inflation in 2022, the FOMC held the FFR at a high level compared to its position over the last decade.

As economists examine the data available to the FOMC, we will take a look at what aspects of specific indicators may inform the decision to lower, raise, or maintain rates next week.

1. Gross Domestic Product

Let’s start with the most recent reports released by the Bureau of Economic Analysis, which showed that in the second quarter of 2024, the US Gross Domestic Product, or GDP, grew by 2.8 percent. This increase is double that seen in the first quarter of the year and is a positive sign that the economy may be able to evade entering a recession in the coming year. Typically, when an economy sees two consecutive periods of negative GDP growth, it is a sign that a recession is taking hold.

For the FOMC, the strong GDP report will indicate that their monetary policy is working to stabilize prices and support economic growth. While a positive macroeconomic sign, the relationship between GDP growth and household economic well-being is not so direct. This brings us to our second indicator, personal income, and savings.

2. Personal Income and Savings

The BEA also released a report this week showing that personal income increased 0.2 percent from May to $23.948 billion in June.

Disposable income, which refers to the money that households can spend, is still increasing, but at a slower rate. It grew by 0.2 percent, half of what was reported in May. The slower growth in personal income indicates that households are still under financial strain as prices are only starting to decrease. Another indicator of this financial stress is the historically low personal savings rate, currently around 3.4 percent. To put that into perspective, in 2019, the average household saved 7.4 percent of their income.

Furthermore, the percentage of income used to repay debts is just below ten percent. Although it’s positive that overall incomes are increasing, the Bureau of Economic Analysis (BEA) does not provide data on how different income groups are faring, making it impossible to know how this additional income is being distributed across various economic classes.

In September, the Bureau of Labor Statistics will release the Consumer Expenditure Survey, which offers information on five income quintiles. The most recent available data is from 2022, revealing that over the past twenty-two years, those at the higher end of the income spectrum have enjoyed the largest income gains.

3. Inflation and Price Stabilization

Based on the Bureau of Labor Statistics, June marked the first month where national average prices decreased since early 2022. The Federal Reserve aims to keep inflation under two percent and has implemented a monetary policy to prevent rapid price increases. Instead of using the CPI, the Federal Reserve relies on the Personal Consumption Expenditure (PCE) to assess price changes. In June, the FOMC published its economic forecasts, indicating that most committee members estimated the median PCE index for 2024 to range from 2.8 to 3 percent. The latest data from June shows a slowdown in price growth, moving closer to the target of two percent or lower.

The core PCE, which excludes food and energy, increased by 0.1 percent, resulting in a year-over-year change of 2.5 percent. Despite the potential for this indicator to prompt the FOMC to start decreasing rates, 95 percent of economists surveyed by the CME Group believe that no change will be announced at the upcoming meeting.

4. Unemployment

One of the more concerning indicators for the FOMC to consider is unemployment. While the national unemployment rate remains at a historic low, it is increasing, and for some economists, that rise is happening too fast. The Federal Reserve has a dual mandate to maintain price stability and create the conditions for full employment (i.e., all those who want a job have one).

Economist William C. Dudley published an op-ed in Bloomberg this week, calling on the Fed to lower rates, arguing that increases in unemployment as inflation has come down highlight a risk for workers. The effect monetary policy has on unemployment is one of the most direct effects the movement of interest rates has on household budgets. In Dudley’s piece, he highlights concerning trends in the labor market that he believes should prompt action from the central bank. If unemployment begins to increase any faster, it could signal a recession is on the horizon, noting that the 0.43 percent bump in the national rate over the last year should signal trouble.

The July Employment Report, which could show a loss of one million jobs compared to the figure captured a year earlier, would be a concern for economists who see quick increases in unemployment as severely disruptive as consumer spending can tighten as workers grow concerned that they could lose their job.

5. Politics

As an election year, the economy is front and center for both major parties. However, there are signs that the economy is recovering from the various shocks it experienced in the years following the COVID-19 pandemic. A severe downturn in the economy at this point in the race would hand a serious electoral advantage to the GOP, who have attacked President Biden and the Democrat’s approach since 2020. In the inverse, a strong economy would be a great talking point for Democrats as they try to convince voters that they would be best served with four more years in the White House.

The Federal Reserve is not a political body and is unlikely to be swayed by campaign rhetoric that it is acting in a political capacity. Whether or not the policy is will be beneficial for the average household, it will stick to its mandate, which has been tilted towards price stabilization as unemployment has remained low. The fear for some economists is that as the economy begins losing jobs, it can be a difficult process to stop.