In his last public speech on the economy and monetary policy before the Fed's pre-meeting blackout period at the end of this month, Federal Reserve Chair Jerome Powell suggested that the U.S. labor market continues to deteriorate. Although the government shutdown has impacted economic assessments, he left open the possibility of a rate cut this month. He also stated that the Fed might stop the quantitative tightening (QT) action of reducing its balance sheet (balance sheet runoff) in the coming months.

In prepared remarks delivered at the annual meeting of the National Association for Business Economics (NABE) this year, Powell said that in the nearly one month since the Fed's policy meeting last month, the outlook for U.S. employment and inflation hasn't changed much. He said that although the release of some important economic data has been delayed due to the U.S. federal government shutdown,

"Based on the data we have, it's fair to say that the outlook for employment and inflation doesn't seem to have changed much since our September meeting four weeks ago."

Powell then pointed out that data before the government shutdown suggested economic growth might be slightly more robust than expected. The unemployment rate remained low in August, and wage growth slowed significantly, possibly partly due to slower labor force growth stemming from reduced immigration and a decline in labor force participation.

"In this less dynamic and somewhat softer labor market, the downside risks to employment appear to have increased."

Powell reiterated in his remarks that due to increased downside risks to employment, the Fed's assessment of the balance of risks to its employment and inflation goals changed, leading to the decision to cut rates in September. To navigate the tension between the dual mandates, "there is no risk-free policy path." He mentioned that existing data and surveys still indicate that "goods price increases primarily reflect tariffs, not broader inflationary pressures."

During the Q&A session, when asked if tariffs could have a slow and sustained impact on inflation, Powell acknowledged that tariffs are a risk, but he pointed out that there is "considerable" downside risk in the labor market. The labor market is slightly tighter than supply.

Powell said the Fed is trying to balance the risks of actions taken to achieve its dual mandate of employment and inflation. Cutting rates too quickly could "lead to a shortfall on the inflation mandate," while cutting too slowly could lead to "painful losses in the job market." He reiterated that the interest rate path is not without risk, saying:

"There really is no risk-free path right now, because [inflation] seems to be continuing to move up slowly... and now the labor market is showing considerable downside risk. Both labor supply and demand have fallen sharply."

Powell said that although the labor market is soft, economic data has been "surprising to the upside."

Powell noted several times on Tuesday that hiring has slowed and indicated that the employment rate could decline further. He said: "Further declines in job openings now are likely to show up in the unemployment rate. After a period of straight-down movement, I think eventually you get to where the unemployment rate starts to rise."

Powell did not provide a specific number for what he considers the breakeven level of job growth needed to keep the unemployment rate stable. He stated that the unemployment rate has clearly declined "substantially." He noted that it's "quite remarkable" that the unemployment rate has changed little despite the slowdown in job growth.

Journalist Nick Timiraos, known as the "new Fed whisperer," wrote that Powell keeps the Fed on track for another rate cut. He suggested that despite inflation concerns, a rate cut this month is still possible due to labor market weakness.

Economist Chris G. Collins commented that Powell saying the outlook hasn't changed much since the September meeting is a way of sticking to the expectation for two more rate cuts this year, as communicated after the September meeting. However, he did not send a strong signal for a cut this month, instead pointing out that "the trajectory of activity growth may be slightly stronger than expected."

Ample Reserves, Signs of Tightening Liquidity, Will Act Cautiously to Avoid 'Taper Tantrum'
Powell expects the Fed may stop balance sheet runoff in the coming months. In his remarks, he stated that the Fed's long-standing plan is to stop when reserves are somewhat above the level the Fed judges to be consistent with ample.

"We may reach that level in the coming months, and we are watching various indicators closely to inform that decision."

Powell acknowledged signs that liquidity is gradually tightening but mentioned that the Fed's "plan indicates they will take cautious steps to avoid money market tensions like those in September 2019." Commentary suggests Powell was referring to avoiding "taper tantrum" market volatility associated with winding down QE.

In September 2019, a "cash crunch" erupted in the U.S. short-term funding market, causing the overnight repo rate to soar to 10%. The Fed was forced to conduct overnight repo operations for the first time in a decade, injecting huge amounts of funds into the money market. Mainstream research suggests the September 2019 repo crisis was a sporadic event occurring in a context of relatively tight liquidity. The main culprits were scarce excess reserves, combined with factors like tax payment dates, heavy Treasury debt issuance, and large banks being required to hold significant reserves due to intraday liquidity regulations.

During the Q&A, Powell said that indicators monitored by the Fed show that reserves in the banking system remain "ample," but there have been some signs of tightening in money market conditions as repo rates have risen.

Inability to Pay Interest on Reserves Would Mean Loss of Rate Control, Cause Greater Market Disruption
This year, some lawmakers have criticized and questioned the Fed's practice of paying interest on reserves held by commercial banks. In his prepared remarks on Tuesday, Powell defended the crucial reserve mechanism tool, stating that the Fed's reserve system is very effective and functioning well. He warned that if the Fed were stripped of its ability to pay interest on reserves, it would lose control over interest rates and cause greater disruption to markets.

Commentary suggests Powell's remarks were clearly responding to criticism from U.S. Treasury Secretary Bethant and other Republicans, which included questions about the Fed's purchases of MBS, suggestions that the Fed should better explain its bond purchases, and doubts about whether it should pay interest on reserves. Powell recalled that perhaps the Fed should have stopped bond purchases more quickly after 2020.

On Tuesday, Powell mentioned that the Fed is considering adjusting the composition of its asset holdings, increasing its holdings of short-term assets.

Collins commented that increasing holdings of short-term assets like Treasury bills is not a new idea. Some investors believe that if the U.S. Treasury increases issuance of short-term bills and the Fed buys a significant portion of them, it would be equivalent to a form of stealth QE because the overall weighted average maturity of outstanding Treasury debt would then be lower.

But Collins pointed out that the Treasury issuing more short-term bills doesn't necessarily flatten the yield curve. The primary driver of the Treasury yield curve remains policy expectations, not changes in net supply.

Other Indicators Cannot Replace Official Data, Asked About Rising Gold Prices
During the Q&A, Powell said that due to the lack of data like the non-farm payrolls report caused by the government shutdown, everyone is looking at the same employment data – disclosed by the private sector. He highlighted state-level employment data and the ADP employment report, often called the "small non-farm payrolls," but stated that none of these can replace the gold standard that constitutes official statistics.

Speaking about alternative data, Powell said some indicators can supplement official government statistics but cannot replace them. He noted that accurately interpreting prices is particularly difficult without government reports.

When asked about rising gold prices, Powell said: "I'm not going to comment on any particular asset price."

When asked about the impact of artificial intelligence (AI), Powell quoted Nobel laureate Robert Solow's famous line about how new technologies affect productivity: "You can see the computer age everywhere but in the productivity statistics." He added, "This may be the same thing."

Powell said Fed officials are keeping a low profile and staying out of politics. "We don't get into a back-and-forth with anyone. That very quickly becomes political." The Fed's sole focus is doing its job for the public. However, he added: "Don't seek perfection. These are necessarily emergency decisions made in real-time."

Powell stated that the Fed does not comment on immigration policy, but he noted that the Trump administration's policies in this area have been tougher than many expected. He said labor force growth and entries have fallen sharply, which could lead to fewer workers. But we are only just beginning to see the effects of these policies.