Higher than expected prices and economic growth have challenged the Fed’s belief that inflation was steadily decreasing
The Federal Reserve has announced that interest rates will remain at a two-decade high until there is further cooling of inflation.
The decision was made public in a statement following the latest meeting, where the key rate was kept at roughly 5.3%, a high not seen in twenty years. Recent reports showing higher than expected prices and economic growth have challenged the Fed’s belief that inflation was steadily decreasing.
This combination of high interest rates and persistent inflation could pose a threat to President Joe Biden’s re-election bid. Chair Jerome Powell stated at a press conference that “inflation has shown a lack of further progress toward our 2% objective.” He added that gaining greater confidence in this area “will take longer than previously expected.”
Despite these challenges, Mr Powell expressed optimism about inflation. He said: “My expectation is that over the course of this year, we will see inflation move back down.” Wall Street traders initially welcomed the prospect of the Fed cutting rates at some point this year, as well as Mr Powell’s comment that the Fed isn’t considering reverting to rate increases to combat inflation. “I think it’s unlikely that the next policy rate move will be a hike,” he said.
Later, though, stock prices erased their gains and finished the day essentially unchanged from where they were before Mr Powell’s news conference. Still, Mr Powell sketched out a series of potential scenarios for the months ahead. He said that if hiring stayed strong and “inflation is moving sideways,” that “would be a case in which it would be appropriate to hold off on rate cuts.”
But if inflation continued to cool – or if unemployment rose unexpectedly – Mr Powell said the Fed would likely be able to reduce its benchmark rate. Cuts would, over time, bring down the cost of mortgages, auto loans, and other consumer and business borrowing.
Those comments were “a signal that the (Fed) is a lot less confident that they know how policies are going to unfold over the course of this year,” said Jonathan Pingle, an economist at UBS. “We were all sort of hoping for an update on the committee’s path forward. And instead what we got was, ‘We’re really not confident enough to tell you what our path forward is going to be.’ “.
The central bank’s overarching message Wednesday – that more evidence is needed that inflation is slowing to the Fed’s target level before the policymakers would begin cutting rates – reflects an abrupt shift. As recently as their last meeting on March 20, the officials had projected three rate reductions in 2024, likely starting in June.
Despite the ongoing high inflation, financial markets are now predicting just one rate cut this year, in November, according to futures prices tracked by CME FedWatch. The Federal Reserve’s cautious outlook is based on three months of data indicating persistent inflation pressures and strong consumer spending. Inflation has eased from a peak of 7.1%, the Fed’s preferred measure, to 2.7%, as supply chains have improved and some goods’ costs have actually fallen.
However, average prices remain significantly above their pre-pandemic levels, and the costs of services such as apartment rents, health care, restaurant meals, and auto insurance continue to skyrocket. With the presidential election just six months away, many Americans have voiced dissatisfaction with the economy, particularly regarding the speed of price increases.
On Wednesday, the Fed announced that it would decelerate the pace at which it’s unwinding one of its largest COVID-era policies: Its purchase of several trillion dollars in Treasury securities and mortgage-backed bonds, an initiative to stabilise financial markets and maintain low longer-term rates.
The Fed is currently allowing $95billion of those securities to mature each month, without replacing them. Its holdings have dropped to about $7.4trillion, down from $8.9trillion in June 2022, when it began reducing them. On Wednesday, the Fed stated it would slow down the reduction of its holdings starting in June.
The Federal Reserve will now allow a reduced amount of $25billion of Treasury bonds to roll off each month, rather than the previous $60billion. Concurrently, it will continue letting $35billion in mortgage-backed bonds mature per month.
Lessening its holdings could contribute to the Fed keeping longer-term rates, including mortgage rates, higher than would otherwise be the case. This is because as it trims its bond holdings, other buyers will have to purchase the securities instead and rates might need to increase to draw in the necessary purchasers.
The health and strength of the US economy is surpassing what most economists predicted for this stage. The nation has held its unemployment rate below 4% for over two years; it’s the longest streak since the 1960s.
Despite economic growth clocking in at just a 1.6% annual pace in Q1 of this year, consumer spending expanded robustly, signalling the economy will maintain its progress. Mr Powell dismissed any worries that the economy is at danger of falling into “stagflation” a harmful mix of sluggish growth, soaring unemployment, and high inflation that plagued the United States in the 1970s.
“I was around for stagflation,” Mr Powell commented, “and it was 10% unemployment, it was high-single-digit inflation. And very slow growth. Right now, we have 3% growth which is pretty solid growth, I would say, by any measure. And we have inflation running under 3%. …I don’t see the ‘stag’ or the ‘flation,’ actually.”