In a pivotal address to the Senate Banking Committee on July 9, Federal Reserve Chair Jerome Powell acknowledged “modest further progress” in controlling inflation, while also highlighting a significant cooling in labor-market conditions. This marked a shift in tone, with Powell reiterating the state of the labor market multiple times in response to lawmakers’ inquiries. The implications are clear: the Federal Open Market Committee (FOMC) is edging closer to cutting rates.

Dovish Tones and Policy Shifts

Powell’s prepared remarks were notably dovish, emphasizing the progress made towards the Fed’s 2% inflation target. However, he balanced this optimism with cautionary notes about the downside risks to the labor market. While the FOMC requires greater confidence that inflation is sustainably moving toward its goal before cutting rates, Powell’s current remarks acknowledged the recent “modest further progress,” a departure from previous statements highlighting a “lack of progress.”

Powell also brought attention to labor-market risks, stating that “elevated inflation is not the only risk we face.” He warned that “reducing policy restraint too late or too little could unduly weaken economic activity and employment.”

Labor Market Cooling

The key takeaway from Powell’s appearance was his acknowledgment that recent data have shown “modest further progress” on inflation, while June’s jobs report sent a “clear signal” that labor-market conditions have cooled “considerably.” The June jobs report unexpectedly showed the unemployment rate rising to 4.1%, surpassing consensus expectations of 4.0%. Powell noted that labor-market conditions had “cooled considerably,” and underscored that Fed officials are acutely aware of the “two-sided risks” facing the economy.

Most Obvious Signals Yet

These are the most obvious signals yet that the FOMC is close to cutting rates. With three more inflation reports due before the September FOMC meeting, it is anticipated that the Fed will have enough confidence to cut by then. Powell’s prepared remarks sounded notably dovish, suggesting progress has been made toward the Fed’s 2% inflation target while emphasizing downside risks to the labor market.

Shift in Fed Priorities

The bottom line is that Powell’s remarks are laden with references to labor-market risks, signaling a potential pivot in the Fed’s priorities. Over the past two years, the Fed has explicitly prioritized price stability. However, with a forecasted rise in the unemployment rate to 4.5% by the fourth quarter, it is expected that the Fed will increasingly prioritize the employment aspect of its dual mandate by year-end.

Powell’s address to the Senate Banking Committee represents a significant moment for the U.S. economy. As the labor market shows signs of weakening and inflation progresses towards the Fed’s target, the FOMC appears poised to adjust its policy stance. This potential shift highlights the delicate balance the Fed must maintain between fostering stable prices and ensuring robust employment levels. Stay tuned for further updates as we approach the September FOMC meeting.