[New York Diary] Fear of R Spreads... Powell Faces Another 'Behind the Curve' Controversy

"Cancel your summer vacation immediately and cut interest rates right now. We cannot wait for six weeks." (Elizabeth, Democratic U.S. Senator)

Jerome Powell, Chairman of the U.S. Federal Reserve (Fed), has once again faced criticism for being behind the curve. After the Federal Open Market Committee (FOMC) held rates steady in July, the "fear of R (Recession)" swept through the U.S. financial markets. Just one day after the Fed’s FOMC meeting on June 31 (local time), where the benchmark interest rate was held steady at 5.25-5.5% for the eighth consecutive time, indicators showed that manufacturing activity and employment were rapidly cooling. Two days after the rate freeze, additional data revealed a sharp rise in unemployment. As if mocking the Fed’s decision, signals of a rapidly deteriorating economy emerged immediately after the rate hold. The New York Stock Exchange plunged, and the 10-year U.S. Treasury yield plummeted to the 3% range for the first time in six months. The July rate hold was widely criticized as a "serious mistake."

[Image source=Yonhap News]

The indicators released after the Fed’s rate hold raised concerns that the U.S. is heading into a recession phase. The real economy and labor market were cooling at an alarming pace. On August 1, the Institute for Supply Management (ISM) reported the July Manufacturing Purchasing Managers’ Index (PMI) at 46.8, significantly below the forecast of 48.8 and the previous month’s 48.5. A PMI above 50 indicates expansion, while below 50 signals contraction; the index has remained below 50 since March, with the contraction accelerating. The following day’s data was also worrisome. According to the U.S. Department of Labor’s July employment report, nonfarm payrolls increased by only 114,000, the lowest since the COVID-19 pandemic began. The unemployment rate rose to 4.3%, up 0.2 percentage points from the previous month’s 4.1%, marking the highest level since October 2021. The "employment risk" Powell mentioned as a possibility for a September rate cut has now become precarious.

The "July rate cut theory" that circulated on Wall Street before this FOMC meeting has now shifted to a "July missed opportunity theory." Critics argue that the Fed could have proactively cut rates in July to secure more room for monetary policy maneuvering but instead closed that window by deciding to hold rates steady. The market is now betting not only on a September rate cut but on a "big cut" of 0.5 percentage points next month. The Wall Street Journal (WSJ) reported, "The Fed may regret not igniting a rate cut in July," explaining that this is why the interest rate futures market is pricing in a 0.5 percentage point cut at one of the remaining meetings this year.

Given the highly volatile U.S. economic data, it is difficult to definitively say whether the economy has entered a recession or if a soft landing is still possible. However, one concern among market participants is Powell’s persistent "data-dependent" approach. This means monetary policy decisions are heavily based on economic data. While data is indeed crucial, the role of the central bank is not only to analyze data but also to implement preemptive monetary policies based on that data to fulfill its dual mandate of price stability and full employment. Waiting to identify trends and gain certainty from data before pivoting risks a "behind-the-curve" response rather than timely action. Powell has a history of misjudgment, having underestimated inflation as temporary in 2021 and only beginning rate hikes belatedly in March 2022.

This time, Wall Street hopes that the judgment that "the Fed’s July rate hold was a misjudgment and the September rate hike will be behind the curve" will prove wrong, rather than Powell himself being at fault.