Federal Reserve's Bowman: The labor market is clearly more fragile, should decisively cut interest rates, favoring the smallest balance sheet

Similar to her recent speeches, Federal Reserve Vice Chair for Supervision Michelle Bowman reiterated that the U.S. labor market is "fragile" and inflation is close to the Fed's target, thus calling for a firm interest rate cut. Unlike before, Bowman also suggested that the Fed should strive to keep its balance sheet at a minimal size and reform its monetary policy implementation mechanism.

In a speech delivered on Friday, the 26th, Eastern Time, Bowman emphasized that the Federal Open Market Committee (FOMC) needs to "act decisively and proactively" to address new signs of weakness in the labor market. She warned again that the Fed risks falling behind the curve in addressing employment risks, and if these conditions persist, it may have to adjust policies more quickly and significantly in the future.

Regarding the balance sheet issue, Bowman clearly stated her preference for a smaller balance sheet size, with reserve balances closer to scarcity rather than abundance. She suggested that the Fed actively sell mortgage-backed securities (MBS), as "relying solely on MBS maturities will not return to a pure Treasury portfolio within a credible timeframe."

Continued Call for Decisive Rate Cuts to Address Employment Risks

On Friday, Bowman pointed out that over the past few months, she has emphasized that the economic situation is changing, and the balance of risks regarding employment and inflation targets has shifted, noting that there may be signs of weakness in the labor market. She believes that the increasingly evident signs of labor market softness provide a basis for the Fed to take proactive measures to support employment goals. She then stated:

"Recent data shows that the labor market is clearly more fragile, while inflation, excluding tariff factors, still hovers around the (Fed's) target level."

In light of this, Bowman said she supported starting to cut rates at last week's FOMC meeting to bring the benchmark policy rate back to neutral levels. Before the July FOMC meeting, although inflation remained within the target range, the FOMC primarily focused on the inflation indicators of its dual mandate.

"Now, as the labor market conditions continue to deteriorate, the (FOMC) committee must take decisive and proactive action to address the decline in labor market vitality and the emerging signs of fragility.

In my view, recent data (including the latest estimates of non-farm payrolls) suggest that our actions to address the deterioration of the labor market may have lagged. If this situation continues, I worry that we will need to adjust policies at a faster pace and with greater magnitude in the future."

On Tuesday, Bowman stated that after seeing "months of deteriorating labor market conditions," it is time for the FOMC to take action to cut rates. She warned at that time that decision-makers face "serious risks of already falling behind the curve" and need to respond decisively and proactively to the decline in labor market vitality.

On Thursday, Bowman continued to emphasize this point, stating that the labor market is more "fragile" than expected, providing a basis for further rate cuts. She believes that when the Fed's dual mandate—maximum employment and price stability—comes under tension, it should "flexibly shift focus to the mission that deviates the most from the target or shows a greater risk of sustained deviation." Bowman further elaborated her position in her speech on Friday:

"I understand and respect the concerns about our failure to fully achieve the inflation target. However, with a flexible policy-making approach, even if inflation is within our target range but still above the target, we should focus on those policy objectives that show signs of deterioration or fragility."

"In my view, taking swift and decisive action when market fragility is evident is far more effective than being forced to make significant adjustments to policy afterward."

Minimize the Impact of the Balance Sheet on Money Markets and Bond Markets

Regarding the balance sheet, Bowman presented a clear long-term vision. She stated:

"In the long run, my preference is to maintain the smallest possible balance sheet, with reserve balances closer to scarcity rather than abundance."

Bowman believes that a smaller balance sheet will "minimize the Federal Reserve's impact on money markets and the Treasury market." She pointed out that holding reserves below abundant levels would allow the Federal Reserve to "return to a mode of actively managing the balance sheet," enabling it to timely identify signals of market stress rather than masking those signals.

In terms of the composition of the balance sheet, Bowman emphasized that only Treasury securities should be held. She stated, "I strongly support the system's open market account portfolio being composed solely of Treasury securities to minimize the impact of the Federal Reserve's asset holdings on the overall credit allocation in the economy."

Regarding MBS holdings, Bowman explicitly suggested active sales. She mentioned in her speech, "I also look forward to reconsidering the (FOMC) committee's considerations regarding the potential sale of our agency MBS holdings. Relying solely on MBS maturities will not return us to a pure Treasury portfolio within a credible timeframe."

Other Views on Monetary Policy Tools

Bowman also proposed adjustments to the Standing Repo Facility (SRF). She advocated that "the minimum bid rate should be above the upper bound of the federal funds rate target range" to emphasize its role as a backup tool rather than a conventional source of financing.

Bowman stated that the current design of the SRF "has not been fully positioned as a backup tool only during periods of market dysfunction and stress." She expressed concern that if the interest rate setting is not high enough, it may still be viewed as an option by primary dealers experiencing special stress, "and in my view, providing an exit for dealers experiencing such stress should not be the intended purpose of this tool."

Bowman also mentioned regulatory proposals for the Enhanced Supplementary Leverage Ratio (eSLR), arguing that it should be restored as a backup tool rather than a binding constraint to improve the intermediation function in the Treasury market. She noted that when leverage requirements become a binding capital constraint for firms, it may suppress low-risk, low-profit activities