By Howard Schneider
WASHINGTON (Reuters) – Federal Reserve officials left their policy meeting in late January in search of “greater confidence” that inflation was on a sustainable downward path, a notably squishy standard they set for determining when the U.S. central bank might start cutting interest rates.
Instead, they’ve have been buffeted by services prices roaring upward, job growth that continues to surprise to the upside, and housing costs that have kept climbing faster than expected.
Far from confidence, the issue they face in the two-day meeting that concludes on Wednesday is whether progress on inflation has flat out stalled and, if so, whether the Fed’s policy rate needs to stay in the current 5.00%-5.25% range longer than anyone – investors, consumers, politicians and U.S. central bank officials themselves – had expected.
That range was set last July after a historic round of aggressive monetary tightening triggered by inflation surging to a 40-year peak. Fresh economic projections due to be released at 2 p.m. EDT (1800 GMT) alongside a new monetary policy statement will show if officials still expect to reduce the policy rate by three-quarters of a percentage point this year, an outlook they’ve held since December and which was premised on inflation’s continued decline.
At a press conference shortly after the end of the meeting, Fed Chair Jerome Powell will elaborate on the new policy statement before being quizzed on whether his recent comment that the U.S. central bank was “not far” from making a decision on an initial rate cut remains the case in the face of faster-than-anticipated price increases.
Another key point is whether the statement will still refer to inflation as “elevated,” an adjective the Fed has used throughout the current tight credit phase and which could be removed to signal that rate cuts are imminent.
Powell will be under pressure from both sides of the debate, as some economists see signs that inflation is becoming lodged at levels too far above the Fed’s annual 2% target to ignore, while others expect an upcoming slowdown in economic growth and hiring to keep price pressures muted and warrant rate cuts soon.
POLITICAL WINDS
Ahead of this week’s Fed meeting, major investment firms scaled back the rate cuts they are expecting this year.
Goldman Sachs went from forecasting a full percentage point of cuts in 2024 to three-quarters of a point. Roger Aliaga-Diaz, the chief economist for the Americas at Vanguard, said between recent data and a “cautious” Fed, “it’s entirely possible that the Fed may not be in position to cut rates this year” at all.
Pantheon Macroeconomics’ chief economist, Ian Shepherdson, who was among the earliest to correctly forecast the dramatic softening in inflation over the course of last year that underpins the now-widely embraced “soft-landing” thesis, meanwhile argued that savings-depleted households were now “exposed” more fully to the Fed’s tight credit policies. Moreover, he said, recent small business surveys suggest hiring could potentially slow sharply in the coming months.
Some Democrats in the U.S. Congress also have peppered Powell with rate-cut demands. With headline inflation running at 2.4% in January by the Fed’s preferred measure – the personal consumption expenditures price index – lawmakers argued in a March 18 open letter to the U.S. central bank chief that keeping monetary policy this tight was not necessary and put the current economic expansion at risk.
The housing market in particular “is facing major imbalances” between supply and demand that won’t get fixed with high interest rates discouraging home and apartment construction, they wrote in a letter signed by members of the Congressional Progressive Caucus and others, including Senator Elizabeth Warren of Massachusetts, a frequent critic of Powell.
MIDDLE PATH
The Fed is grappling with other issues that could become evident at the end of this week’s meeting, including whether a recent jump in productivity or changes in labor supply have raised the economy’s potential, whether underlying interest rates have also increased, and whether it is time to slow the monthly decline in the central bank’s massive holdings of U.S. Treasuries and other assets.
The pressing decision, however, is when to begin the rate cuts, a “pivot” that has been underway since late last year.
The Fed has been laying the groundwork steadily but has held off committing to a start date for the easing cycle in part because policymakers feel the worst-case outcome would be for inflation to stall or reaccelerate after they had begun to lower borrowing costs. That’s a problem largely avoided by waiting to cut rates, while the economy’s ongoing strength, as seen in heady economic growth and an unemployment rate that remains below 4%, also has bolstered the bias towards waiting.
Central banks globally are doing the same sorts of analysis as they engineer an epochal change in financial conditions away from years of near-zero or even negative interest rates to an era where many analysts expect borrowing costs to remain above the rate of inflation, a significant benchmark which means that borrowed money comes at a “real” cost.
The Bank of Japan on Tuesday ended its – and possibly the world’s – experiment with negative interest rates by approving its first hike in borrowing costs in 17 years, joining the global tightening of monetary policy triggered when the COVID-19 pandemic and other factors led to a worldwide breakout of rising prices.
If Powell is true to his recent form, he is likely to walk a middle path on Wednesday, acknowledging that inflation remains sticky but also maintaining for now the central bank’s baseline expectation that price pressures will continue to ease, if slowly, and eventually pave the way for interest rates to fall.
The Fed “will remain noncommittal about the timing of the first rate cut as inflation has surprised to the upside and there are no glaring fissures in the economy,” Ryan Sweet, the chief U.S. economist at Oxford Economics, wrote this week. If there’s change in the outlook, he said, it would be towards fewer and later cuts.
“Though the Fed knows that disinflation is in the pipeline, risk management could lead them to favor underpromising on rate cuts this year and potentially overdelivering,” he said.
