【MACRO Alert】The Delicate Dance of Economic Policy: The Fed and the Bank of Japan in an Era of Uncertainty

In 2024, the complexity of the U.S. economy is increasing, and the Federal Reserve faces the daunting task of finding a balance between the job market and inflation. Richmond Fed ChairmanBarkin, in recent comments, noted that the current “low hiring, low firing” employment decision-making approach adopted by U.S. companies may not last. He emphasized that if the economy further weakens, companies may begin layoffs. This view echoes the Fed's concerns about the job market and is also one of the main reasons why Fed Chairman Powell mentioned rate cuts in recent speeches to prevent the unemployment rate from deteriorating further.

At the Fed's economic symposium,Barkin stated that although companies have become more cautious in hiring, there has not yet been a large-scale layoff situation. He predicted that in the future, either demand growth will drive recruitment, or layoffs will occur. Currently, the U.S. unemployment rate has steadily risen to 4.3%, an increase mainly due to slower recruitment and more people entering the job market, rather than large-scale layoffs.

To address the downward risks in the job market, the Fed is almost certain to cut rates at the September meeting.Barkin proposed that he tends to adopt a “trial and error” approach to rate cuts, likely supporting a 25 basis point cut, rather than the 50 basis point cut some analysts predicted. He also pointed out that although the inflation rate is still higher than the Fed's 2% target, rate cuts may stimulate demand for housing and other goods, thereby fueling inflation. It is worth noting that as a FOMC voter,Barkin is optimistic about the relief of price pressures, especially as the disinflation process becomes more widespread, no longer limited to the commodity sector. He mentioned that the U.S. has experienced low inflation growth for four consecutive months, indicating that concerns about a re-acceleration of inflation have eased.

On the other hand, the Fed's focus in 2022 shifted to fighting inflation, having to quickly raise interest rates to keep up with the rapid rise in inflation. Two years later, the Fed's focus changed again, this time to protect the job market. Powell's speech at the Fed's annual Jackson Hole conference hinted at an impending rate cut, marking a dovish shift by the Fed since January of this year, when the Fed acknowledged emerging risks in the job market and made them a top priority.

Currently, a key question is whether the weakness in the job market and the rise in the unemployment rate are just a sign of stable economic growth, or the beginning of an economic slide. The upcoming non-farm employment report will provide answers, which will determine how much the Fed needs to lower interest rates to prevent further unwanted weakness in the labor market. Powell stated that he does not want the labor market conditions to cool further, which seems to imply that he sees the current U.S. unemployment rate of 4.3% as a level that needs to be defended. He recalled the low unemployment situation when he served as Fed Chairman in 2018 and expressed a desire to see such conditions again after the pandemic.

At present, the federal funds rate is 5.25%-5.50%, a level considered to restrict economic growth and endanger job positions. If inflation continues to move towards the Fed's 2% target, changes in the job market will determine how quickly officials move towards the neutral interest rate level, and whether they need to further reduce interest rates to restore full employment.

The Fed's fight against inflation has raised interest rates to a 25-year high without obvious negative impacts on the job market. Officials will start their actions at the September meeting with a stance quite different from a few weeks ago, as they prepare to cut rates and discuss whether the job market is slowing down or on the edge of a cliff. The Fed's rhetoric around risks has steadily changed this year. From “closely monitoring” in January to “monitoring” the job market and inflation in July, Powell's speech completed this journey, pointing out that “the balance of risks to the Fed's dual goals has changed,” and policymakers will “do everything to support a strong labor market.”

The Fed's dovish shift may bring some breathing room for the Bank of Japan's fight against the weak yen, but if the policy path divergence between the two central banks makes the market uneasy, then the Bank of Japan's efforts to raise interest rates may become more complicated. At the annual economic symposium held in Jackson Hole, Wyoming, Fed Chairman Powell sent the strongest signal for a rate cut so far. He said that due to the rising risks in the job market and no room for further weakness, the time for policy adjustment has come.

A few hours before these remarks, Bank of Japan Governor Haruhiko Kuroda said in Congress that the Bank of Japan will closely monitor the impact of market instability, but if the inflation rate is still expected to reach the 2% target on a sustainable basis, the Bank of Japan will continue to raise interest rates. The yen rose against the dollar after Kuroda's speech, and the increase expanded due to Powell's speech, as the market focused on the prospect of the narrowing interest rate gap between the U.S. and Japan. The rapid appreciation of the yen triggered a wave of closing popular carry trades, causing turmoil in the global financial market.

The rebound of the yen has been a relief for the Bank of Japan. The Bank of Japan has been under political pressure, with politicians calling for it to prevent the depreciation of the yen, as the rising cost of imported food and fuel will harm consumption. As Japan goes against the global trend of rate cuts, the yen and the Japanese stock market face the risk of violent fluctuations, which makes the Bank of Japan's path to raising interest rates full of uncertainty. After the Bank of Japan raised rates in July, the market experienced violent fluctuations, and the Bank of Japan has felt the need to act cautiously. And with Prime Minister Fumio Kishida, who appointed Kuroda as head of the Bank of Japan, stepping down in September and passing the baton to the winner of the ruling party's leadership election, domestic political factors also make the Bank of Japan's path to raising interest rates more complicated.

Although most of the main candidates to succeed Kishida support the Bank of Japan's plan to raise interest rates moderately, it is uncertain whether the new prime minister will support raising interest rates if the turbulent market drags down corporate profits. Former Bank of Japan committee member Makoto Sakurai said, “With so much uncertainty, the Bank of Japan may not be able to take bold measures.” He said, “It may be difficult for the Bank of Japan to raise interest rates until the domestic political situation stabilizes.” The latest Reuters poll shows that most economists expect the Bank of Japan to raise interest rates again this year, but more people believe that the rate hike is likely to happen in December rather than October.

The Fed faces multiple challenges in the current economic environment, needing to find a delicate balance between maintaining job market stability and controlling inflation. As economic data continues to change, Fed policymakers must adjust their strategies flexibly to deal with various possible economic situations. The Fed's decisions will have a profound impact on the U.S. and global economies. At the same time, the Bank of Japan also faces complex decisions on whether to continue raising interest rates while dealing with the weakness of the yen and domestic political pressure. The fluctuations and uncertainties in the global financial market have increased the difficulty of the Bank of Japan's decision-making, and its policy direction will have an important impact on the Asian and global economies.