The Forecast is Murkier as Data Continue to Show Surprising Economic Strength
Key Takeaways
Federal Reserve officials who set the nation’s monetary policy are divided about how quickly, and how much, to cut the central bank’s benchmark interest rate.
Some fed officials believe inflation is subdued enough to begin to ease up on high interest rates relatively soon.
Others believe recent reports showing stubbornly high inflation are a warning sign that the Fed should keep rates higher for longer to ensure inflation doesn’t make a comeback.
The latest rounds of data on inflation and the economy have left policymakers at the Federal Reserve in limbo about when, and how much, they should cut interest rates.
In recent speeches, Fed officials were divided on how to interpret recent reports showing an economy potentially resisting the impacts of sustained high interest rates. Inflation is staying stubbornly above the central bank’s goal of a 2% annual rate, while the job market chugs along at a healthy clip, and consumers keep spending like there’s no tomorrow.
Fed officials face the decision of when to cut the central bank’s influential fed funds rate from its current range of 5.25% to 5.50%, where it’s been since July. The Fed has held it at its current level, its highest since 2001, pushing up borrowing costs for credit cards, mortgages, and all kinds of other loans to slow the economy and cool inflation.
The Fed’s mission, given to it by Congress, is to use monetary policy to promote stable prices and full employment—goals that sometimes conflict with one another.
Inflation has fallen significantly from its peak in the summer of 2022. Now the Fed is weighing the risks of keeping the rate high, potentially causing an economic crash. The alternative is cutting interest rates, potentially overheating the economy and causing inflation to flare up again.
Powell Seeks Confidence Inflation Will Fall
Members of the central bank’s policy committee have been weighing those risks differently. The most influential member of the Federal Open Market Committee, Fed Chair Jerome Powell, has articulated a “wait and see” approach to determine whether the latest uptick in inflation was just a fluke or a genuine setback. He repeated that line of thought in a speech Wednesday at Stanford Business School.
“On inflation, it is too soon to say whether the recent readings represent more than just a bump,” he said. “We do not expect that it will be appropriate to lower our policy rate until we have greater confidence that inflation is moving sustainably down toward 2%. Given the strength of the economy and progress on inflation so far, we have time to let the incoming data guide our decisions on policy.”
The FOMC started discussing the possibility of cutting interest rates at its December meeting, with the median projection among committee members at the time calling for three quarter-point cuts by the end of 2024. At the FOMC’s latest meeting in March, the expectation for three cuts—based on the quarterly economic projections of committee members—was maintained.
As of late Wednesday, financial markets were pricing in about a 60% chance that the central bank will cut rates beginning in June, with the most probable scenario for the rest of the year being for three quarter-point rate cuts, according to the CME Group’s FedWatch tool, which forecasts rate movements based on fed funds futures trading data.
However, the likelihood of cuts priced in by the fed funds market has fluctuated in recent days as investors have digested the latest economic numbers and the flurry of comments from Fed officials. The rising uncertainty about what the Fed will do has also weighed on stock market sentiment, which has been boosted in no small degree over the past several months by expectations interest rate cuts are imminent.
Fed Officials’ Views Diverge
Other FOMC members have been more specific than Powell about how many rate cuts they think would be needed this year. And they aren’t in agreement.
Mary Daly, president of the Federal Reserve Bank of San Francisco said three rate cuts was “a very reasonable baseline” when asked about rate cut plans at a fireside chat event Tuesday in Las Vegas. However, she cautioned that the Fed could keep interest rates higher if inflation stayed higher, or cut them sooner if the labor market started to falter.
Raphael Bostic, president of the Federal Reserve Bank of Atlanta, said only one rate cut was likely and that it would take place in the fourth quarter.
“If the economy evolves as I expect, and that’s going to be seeing continued robustness in GDP, and employment, and a slow decline of inflation through the course of the year, I think it would be appropriate for us to start moving down at the end of this year, the fourth quarter,” he said Wednesday on CNBC’s “Squawk Box” show. “We’ll just have to see where the data come in.”
Last week, Fed Governor Christopher Waller said recent economic numbers have made him push back his expectations for when rate cuts would be warranted.
“Adding this new data to what we saw earlier in the year reinforces my view that there is no rush to cut the policy rate,” he said in a speech at the Economic Club of New York. “Indeed, it tells me that it is prudent to hold this rate at its current restrictive stance perhaps for longer than previously thought to help keep inflation on a sustainable trajectory toward 2%.”
While recent FOMC decisions have been unanimous, some Fed watchers say the increasing disagreement among policymakers in the recent public remarks makes predicting the outlook for interest rates murkier than usual.
“Differences in opinion are increasing at the Fed, even beyond Powell and Waller, who are considered the two most important voices on the FOMC,” Aditya Bhave and Michael Gapen, economists at Bank of America Securities, wrote in a commentary Wednesday ahead of Powell’s speech. “Policymakers appear to differ on how to balance the dual mandate: Should the Fed accept a longer path back to 2% inflation in order to ensure a soft landing?”
In conclusion, as economic data continues to show surprising strength, Federal Reserve officials are faced with tough decisions regarding interest rates and inflation. The diverging views among policymakers have created uncertainty in financial markets and raised questions about how best to balance economic growth with stable prices. The coming months will be crucial in determining how the Fed navigates these challenges and guides the economy towards sustainable growth.
