SFC Markets and Finance | Dean Baker: Two 25-basis-point rate cuts are expected this year

南方财经全媒体记者 见习记者梁旭琦 广州报道

As the U.S. economy experiences steady but moderated growth, understanding the drivers of recent shifts is critical. Inflation is edging closer to the Federal Reserve's 2% target, and the latest GDP data for the third quarter shows a 2.8% growth rate, slightly below expectations. Meanwhile, the PCE price index, a key inflation measure, recorded a 2.1% increase year-over-year in September. October's employment report, impacted by recent hurricanes, showed the U.S. added just 12,000 jobs—the final snapshot of the labor market before election day—while the unemployment rate held steady at 4.1%. These indicators underscore a stable yet cautious economic outlook as the Fed considers future interest rate adjustments in a complex global context.

In this episode of SFC Markets and Finance, Dean Baker, Senior Economist and Co-Founder of the Center for Economic and Policy Research, shares insights into the prospects for inflation, GDP growth, and labor market dynamics leading into the election period. His analysis sheds light on how these economic indicators could shape the Fed’s approach and what may lie ahead for the U.S. economy.

The U.S. economy grew by 2.8 percent in the third quarter, which did not meet expectations. What factors held back growth, and what were the main drivers?

There are two main factors. Most of us were expecting growth a bit over 3%, so at 2.8%, it wasn’t a huge miss—still pretty strong growth for the United States. Two factors were easily identifiable for the shortfall.

First, the trade deficit expanded, which subtracted a bit more than half a percentage point from growth this quarter. The second factor was a slower rate of inventory accumulation. We were still building up inventories, but at a slower rate than in the second quarter, which subtracted about two-tenths of a percentage point from growth.

One of the key categories many of us look at is final demand for domestic product, which excludes trade and inventories. This metric showed a solid 3.5% growth, a rate anyone would consider quite strong. So, to the extent it was a slight miss, the reasons were easily explained.

As for the strongest factors, consumption was by far the biggest driver. Consumption makes up about 70% of our economy, so it was the main factor, especially in durable goods—a notable jump in car sales was a significant contributor. Services also grew at a healthy rate of about 2.5%, which matched expectations. It wasn’t extremely fast, but it was a healthy pace, which is reassuring.

Investment grew around 3.5%, slightly slower than before. We saw a shift there; while structural investment had been growing strongly, with a big surge in factory construction, it slowed considerably. We’re at high levels, but maintaining that previous rate of growth wasn’t realistic. Structural investment actually fell a bit, while equipment investment picked up to fill the gap.

Overall, the economy appears strong, with solid investment and consumption growth. The trade deficit reflects that we’re growing faster than some of our trading partners—China is experiencing rapid growth, while Europe is not, and that’s the world economy in summary.

So by almost any standard—and certainly by my reckoning—this presents a very positive economic picture.

Turning to inflation, the latest PCE figures give us some new insights. What trends are you seeing, and where do you expect inflation to head next?

What we're seeing is exactly what the Fed wanted: inflation continues to slow toward the 2% target, now at 2.1% year-over-year. While the European Central Bank views 2% as a ceiling, Jerome Powell sees it as a target. At 2.1%, we may even drop below 2% soon, and I can't imagine the Fed is particularly worried about the current 2.1% level.

The core inflation rate, which excludes food and energy, is a bit higher, at 2.7% year-over-year, but there are specific factors keeping it elevated. Rental inflation has been a significant factor holding up overall inflation, primarily due to how rents are measured. When calculating rents, we include all rental units, and most people don’t move annually. Many have leases for one to three years, locking in rent increases from tighter market periods, like 2022.

There are separate indexes that measure units changing hands when people move, and these show a much lower rate of rental inflation. This suggests that overall rental inflation will converge toward the rate seen in new rental agreements. As a result, we're getting very close to the 2% target.

I think most people who closely track inflation data are confident we're on track to reach 2% again.

The labor market also remains resilient, with strong job creation reported. Do you see this as a sign of optimism in the job market, and does it help ease concerns about a potential economic recession?

So there had been a lot of concerns about a recession because we have the Sahm Rule. The economist who developed it, Claudia Sahm, used to work at the Fed.

Put simply, if we see an increase in the unemployment rate by more than half a percentage point, it suggests a recession may be on the way. We did see such an increase: the unemployment rate hit a low of 3.4% last April and then rose to 4.3% in July. This understandably caused a lot of concern.

However, the unemployment rate has since fallen—once in August and again in September. So I don't believe a recession is imminent. The labor market still appears strong. For what it's worth, Claudia Sahm herself has noted that the Sahm Rule is only a rule of thumb, not a law of nature. I see no reason to think we're on the brink of a recession.

Which sectors would you say are currently showing the strongest job growth, and what factors are driving this trend?

Consistently, the strongest job growth has been in health care, and for kind of obvious reasons—we’re an aging nation. With demand steadily increasing, health care has become a major driver of employment growth. In some months, it has even accounted for close to half of private sector job growth.

Another key sector is construction, which, to my surprise, continues to add jobs at a strong rate, around 25,000 to 30,000 per month. When we’re creating 100,000 total jobs, that’s a significant share. So, construction remains a robust sector.

Restaurants are also seeing strong growth. As incomes rise, people dine out more, and we’re seeing about 25,000 to 30,000 new jobs each month in this sector. These are currently the strongest industries.

Manufacturing was stronger earlier in the recovery but has now mostly leveled off. In fact, it’s seen a slight recent decline. While I don’t expect a major drop, manufacturing is no longer a growth leader.

Looking ahead, what major trends do you foresee in the U.S. labor market?

The election will be a big source of uncertainty, but one thing we know for certain is that we have a huge baby boom cohort—those born after World War II—who are now reaching retirement age and retiring in large numbers, a trend that will continue.

If we look only at the native-born population, we wouldn’t see much labor force growth. The growth has come entirely from immigrants, who fueled the rapid job growth we saw in 2022 and 2023. Looking forward, much of what happens in the labor market will depend on the pace of immigration, which has sharply slowed due to policy restrictions. This slower pace means slower growth in jobs and the labor force.

Another key factor is productivity growth, which has been strong, at around 2% annually—a significant increase from the 1% annual growth we saw in the decade before the pandemic. Over a decade, this difference translates to roughly 10% more GDP and potentially 10% more wage growth, making a huge impact if sustained. Everything we’re seeing suggests that this productivity growth is continuing, which would lead to higher wages for workers.

Additionally, we've seen significant wage growth at the bottom of the wage ladder, particularly since the pandemic. Unlike in the 80s, 90s, and early 2000s, when most wage growth went to high-income earners, recent tight labor market conditions have boosted wages for lower-income workers. If we maintain a tight labor market and low unemployment, this trend could continue, which I see as a very positive development.

These are the main factors I am watching.

With these recent economic updates, what moves do you expect from the Fed in its November and December meetings?

I’d be surprised if they don’t lower rates by a quarter point at their November meeting. Chair Powell has been clear about closely watching the data. I don’t think they’ve seen anything that would discourage them from making another quarter-point cut.

As for December, if I had to make a guess now, I’d expect another quarter-point cut. However, we’ll have more data by then. If November’s data looks similar to what we’ve seen for September and October—moderate—then I believe we’re on a path toward lower rates.

I don’t think we’re going back to pre-pandemic rates, especially not to the very low rates during the pandemic or even the around-2% rates from before. But I wouldn’t be surprised if we get down to a bit above 3%, though this won’t happen immediately; it’s more likely sometime next year.

How do you evaluate the Fed's approach so far in balancing interest rates to manage inflation while also supporting economic growth?

You can always look back and ask, did the Fed do it perfectly? Of course, they never do. On the one hand, I’d say the result is actually quite good. If you just showed me the data—today's inflation rate and the unemployment rate—I wouldn’t be unhappy; it would be hard to complain.

But on the other hand, did the Fed really need to raise rates as much as they did? I’d say maybe they didn’t. There were three rate hikes of 3/4 points (75 basis points), which struck me as a lot. Even a half-point (50 basis points) might have been enough to slow inflation effectively.

I think they went further than necessary, and they could have started lowering rates earlier—perhaps in June or certainly by July. They could have eased rates at least one meeting sooner, and maybe even two, without risking inflation. So, the rates stayed high longer than needed. But again, hindsight allows us to question things that seemed right at the time. If I were Jerome Powell, I might still feel he made the right call overall.

One other thing about Fed policy that hasn’t received enough attention is the impact on the housing market, not just the labor market. Yes, raising rates slowed job creation, but my main concern is really with housing. Mortgage rates, which had dropped below 3% during the pandemic, jumped to almost 8%, and at one point may have exceeded 8% last year. Though they’ve come down to around 6%, they’re still elevated and have ticked up recently. Lower rates would have greatly benefited the housing market.

I’m not thinking so much about employment, though lower rates would affect that, but more about people's lives. Many people couldn’t move because they couldn’t sell their current homes or afford new ones. First-time homebuyers especially struggled. This is the main reason I wish the Fed hadn’t raised rates as aggressively—not because of the labor market, but because of the impact on housing.

Given the current economic indicators, would you say a soft landing is within reach for the economy?

I'd say we achieved the landing, with inflation basically at the Fed's target. The main issue is rents, but as I mentioned, those are trending downward. It's essentially baked in, as we know that the rental indexes are moving toward the market indexes.

Of course, I’d prefer if the unemployment rate were 0.2 or 0.3 percentage points lower; that would be ideal. But historically, a 4.1% unemployment rate is already very strong. We often look back at the late '90s as a period of several good years, and even then, unemployment only briefly dipped to around 4%. So, 4.1% is really nothing to complain about. Sure, I’d like to see it a bit lower, but it's hard to be dissatisfied with 4.1%.

Now, as the presidential election approaches, what impact do you anticipate it will have on market dynamics and investor behavior? Are there specific sectors likely to be affected more than others?

It's a good question. If Harris were to win, I think we would see lower interest rates very quickly. One thing that others have noticed is that long-term interest rates have ticked up, and a lot of that is due to an inflation premium. I don't think they believe Harris is about to cause inflation because we will largely see a continuation of Biden's policies. She has indicated ways in which she will change, but not in significant ways, so I don't think that would have a big impact on interest rates.

On the other hand, with Trump, the situation gets very complicated because none of us really know what he will do. He says he is going to impose big tariffs. Will he follow through? He talks about it everywhere. If he does impose those big tariffs, we are going to face a lot of inflation, which will push up interest rates. That would be a significant change. He is also proposing big tax cuts. Will he be able to implement those? Hard to say, as many of them are just campaign promises. He said, "we're going to make tips tax-free," which is kind of crazy. Then he also mentioned making overtime tax-free, along with a few other proposals that don't make much sense. Would he actually do them? I don't know.

But if he does follow through, we would probably see a much higher budget deficit. Would that lead to higher interest rates? The Fed's reaction would probably be, "If we're going to have a much higher budget deficit, then we should push interest rates higher."

In summary, I think we would see higher inflation and higher interest rates if Donald Trump enters the White House. As for which sectors would be affected, it’s difficult to say. Ostensibly, he claims he wants high tariffs to promote our manufacturing industry. It sounds like that would help manufacturing, except that manufacturing is very integrated with the world economy. We don’t have a manufacturing industry that is entirely dependent on domestic production. They’re importing parts from China and Europe, so if they suddenly have to pay much higher prices for those parts, I’m not sure that helps manufacturing.

He does say he wants to increase military spending, which could be good for the defense industry, but I don't really know how much he would end up increasing it. Therefore, it’s very hard to predict what sort of policies he would actually pursue if he gets into the White House.

I think people will be reasonably comfortable if Harris wins, as there would not be big changes. That’s how people perceive her, and I think it's a reasonable assumption that it would be a continuation of Biden's policies, which people might either support or oppose.

However, if Trump were to win, it would really create a chaotic situation. I think everyone would be trying to guess whether he is going to impose these tariffs and which tariffs they would be since he has not been very specific. He mentions percentages like 10%, 20%, and even a 60% tariff on China. Will he actually implement these? Sometimes he throws out higher numbers, so I think it will be difficult. People will be trying to figure out which parts of what he said he will actually do.

I expect to see a lot of erratic movements in the markets as people try to anticipate what his administration will do and what he or his treasury secretary's top advisers are saying. At this point, I don't think anyone could tell you what he will actually try to do.

Given these election-driven changes, what general advice would you offer to investors navigating potential shifts in the landscape?

I would strongly suggest maintaining some caution. Our stock market has skyrocketed this year, likely surprising just about everyone. I would recommend some hedging. It certainly can go higher, but it is very high right now, and I think there's a lot of risk.

There’s even more risk with Trump, because we don't know what policies he will pursue. But even with Harris, the market is already very high. So, I would strongly suggest hedging bets, especially if you have substantial investments in the U.S. market, and probably diversifying in other countries. That’s my recommendation.

Finally, as we consider the possibility of a new administration, what potential shifts in trade policies can we expect, and how might these impact the U.S. and global markets?

If Harris gets in, I don't think we will see big changes in policy. In fact, there has been an attitude in society that we need to be hostile to China, almost as if it were an end in itself. Obviously, there are differences both in trade and policy more generally between the U.S. and China. But I would hope there would be an effort to negotiate and reduce tensions rather than increase them. Whether she will do that, I don’t know.

Before the election, she likely won’t, because that’s politics. But after the election, there might be a window of opportunity to take a different approach with China. We do not have major conflicts with Europe, Japan, or Canada. We have trade deals with them, and they have very low tariffs on imports from the U.S. There will always be some minor issues here and there, so I’m not saying everything is entirely harmonious, but these are on a small scale.

With Harris, my hope is that we would reduce focus on tensions with China while keeping policy relatively stable otherwise.

With Trump, however, it will obviously be more conflictual, depending on how far he carries his tariff plans. I really have no idea what he intends, as I don’t fully understand the motivation behind it.

(This interview was conducted prior to the release of the U.S. October non-farm payrolls. The interviewee's views may change based on the latest data and developments.)

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监制：施诗

责任编辑：李依农

记者：见习记者梁旭琦

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出品：南方财经全媒体集团