In late January, Federal Reserve officials were seeking more assurance that inflation was on a steady decline. This "squishy standard" was crucial to their decisions on when to lower interest rates. However, their confidence was challenged by unexpected developments. Surging service prices, robust job growth, and rising housing costs all contributed to uncertainty about the direction of inflation.
During their recent two-day meeting, Federal Reserve officials grappled with the possibility that progress on reducing inflation has halted. This raised concerns about maintaining the current interest rate of 5.00%-5.25% for longer than anticipated by various stakeholders including investors, consumers, politicians, and even the Federal Reserve itself.
The existing interest rate range was established in July following an aggressive monetary tightening phase, initiated in response to inflation reaching a 40-year high. Upcoming economic projections and a new monetary policy statement were expected to clarify whether officials still foresee a three-quarter percentage point reduction in the policy rate, a stance maintained since December based on the anticipation of continued inflation decline.
Fed Chair Jerome Powell was scheduled to provide further details in a press conference following the meeting. His remarks were highly anticipated, especially regarding whether his earlier statement about the Fed being close to an initial rate cut still held true in light of recent price increases. Additionally, the Fed’s statement's language on inflation, particularly whether it still labels it as "elevated," was seen as indicative of potential imminent rate cuts.
The debate surrounding the Fed's approach includes differing views among economists. Some argue that inflation is too high above the Fed's 2% target, while others foresee economic slowdown and hiring deceleration justifying rate cuts. Politically, some Democrats in Congress have pressured Powell for rate cuts, citing concerns about the economy and the housing market.
Major investment firms like Goldman Sachs have revised their rate cut forecasts for 2024, reflecting the changing economic landscape and the Fed's cautious approach. Economists like Ian Shepherdson of Pantheon Macroeconomics have highlighted the vulnerability of savings-depleted households to the Fed's tight credit policies and predicted potential hiring slowdowns.
The Federal Reserve also faces other issues, such as the possibility of increased economic potential due to jumps in productivity or changes in labor supply. This meeting comes at a time when global central banks are transitioning from near-zero or negative interest rates to higher rates. For example, the Bank of Japan recently ended its negative interest rate policy.
Powell is likely to adopt a balanced approach, acknowledging persisting inflation while maintaining expectations of gradual inflation reduction and future rate decreases. The Fed may avoid committing to a rate cut timeline due to risks of inflation stalling or reaccelerating. However, with the economy showing strength, there's speculation that any changes in outlook might involve fewer and later rate cuts, with the Fed possibly favoring a cautious approach in their rate cut promises.
The Federal Reserve's pressing decision revolves around when to initiate rate cuts. This strategic pivot, under consideration since late last year, is being approached cautiously. Officials are wary of cutting rates prematurely, especially if inflation were to stall or reaccelerate. The economy's continued robustness, evidenced by strong growth and low unemployment rates, further supports a cautious stance.
Central banks around the world, including the Federal Reserve, are engaged in a similar analysis as they navigate a significant shift in financial conditions. Moving away from a period of extremely low or negative interest rates, there is an expectation that borrowing costs will remain above inflation rates, implying real costs for borrowed money. This global trend was marked by the Bank of Japan's recent shift away from negative interest rates, a major change after 17 years.
In line with his recent statements, Fed Chair Jerome Powell was anticipated to strike a balance in his approach. While acknowledging the stubborn nature of inflation, he was also expected to reinforce the Fed's base scenario of a gradual easing of price pressures. This approach suggests a cautious path forward, balancing the need to manage inflation risks with the recognition of economic strengths and the potential for disinflation.
Economists like Ryan Sweet from Oxford Economics predict that the Federal Reserve may lean towards promising fewer and later rate cuts this year. This stance would be in line with a risk management strategy, where the Fed prefers to underpromise on rate cuts to avoid the adverse impact of reaccelerating inflation after easing monetary policy. The focus remains on managing inflation effectively while cautiously navigating the economic landscape.
In summary, the Federal Reserve, amidst a complex and evolving economic environment, appears to be taking a measured and balanced approach. This includes carefully considering the timing of rate cuts, acknowledging ongoing economic strengths, and remaining vigilant about potential shifts in inflation dynamics and their broader impact on the economy. Source: Reuters.
20.03.2024
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