Fed meets amid fears inflation rise may stop

So far, the slowdown in rapid inflation in the United States has been a surprisingly painless process. High interest rates make it expensive to get a mortgage or borrow to start a business, but they have not slowed economic growth or drastically increased unemployment.

However, price increases have been hovering around 3.2 percent for five months now. This stagnation raises questions about whether the final phase of the fight against inflation could prove more difficult for the Federal Reserve.

Fed officials will have a chance to react to the latest data on Wednesday, following a two-day policy meeting. Central bankers are expected to leave interest rates unchanged, but their new quarterly economic projections could show how the latest economic developments influence their view of the number of rate cuts coming this year and next.

The Fed's most recent economic estimates, released in December, suggested that Fed officials would make a three-quarter rate cut by the end of 2024. Since then, the economy has remained surprisingly strong and the Inflation, although still down sharply from its 2022 peaks, has proven stubborn. Some economists think it's possible that authorities will scale back their forecasts for rate cuts, planning only two measures this year.

By keeping rates high a little longer, authorities could maintain pressure on the economy, thereby guarding against the risk of a resurgence in inflation.

“The Federal Reserve should not be in a race to cut rates,” said Joseph Davis, Vanguard's global chief economist, explaining that the economy has held up better than would be expected if the Rates were drastically weighing on growth, and that a premature cut risks allowing inflation to heat up in 2025. “We're looking more and more likely that they won't cut rates at all this year. »

Mr. Davis's team is an exception in this regard: Investors at large There remains a very small chance that the Fed will keep rates at their current level of 5.3% until 2024.

But markets regularly revise the number of rate cuts they expect. Investors are now betting that central bankers will cut rates three times by the end of the year, to around 4.6%. Just a month ago, they expected four cuts and saw a reasonable chance of five.

Two major developments have modified these views.

Inflation was firmer than expected. The consumer price index exceeded economists' forecasts in January And FEBRUARY because inflation in services has proven stubborn and the price of some goods, such as clothing, has increased.

Wholesale inflation – which measures the cost of purchases made by businesses – also appeared hotter than expected in data released last week. That's important because it feeds into the personal consumption expenditures inflation index, a later measure but one that the Fed officially targets in its 2 percent inflation target.

Given the data, Fed officials will likely use the meeting to debate “whether inflation can continue to cool,” wrote Diane Swonk, chief economist at KPMG US, in a research note.

“The concern is that the low-hanging fruit associated with healing supply chains and falling goods prices have been picked, while a bottom may be forming under prices in the goods sector. services,” she explained.

The second development is that the economy is still very dynamic. Job gains were solid in February, even though the unemployment rate increased slightly, and wage growth decelerates only slowly. If the economy remains too strong, it could keep the labor market tight and wages rising, prompting companies to raise prices. This could make it difficult for the Fed to sustainably combat inflation.

The Fed does not want to lower interest rates prematurely. If the central bank fails to quickly bring rising prices under control, it could convince consumers and businesses that inflation is likely to be higher in the future. This could make it even more difficult to combat inflation in the future.

At the same time, the Fed doesn't want to keep interest rates high for too long. If so, it could hurt the economy more than necessary, costing Americans jobs and wage gains.

Fed officials have been signaling for months that interest rates will come soon, but they have also tried to keep their options open on the timing and magnitude.

Jerome H. Powell, the Fed Chairman, said in recent congressional testimony that it would be appropriate to lower interest rates when the Fed was satisfied that inflation had fallen sufficiently, adding: “And We are not far from it.”

But several of his colleagues struck a cautious tone.

“At this point, I think the biggest mistake would be to cut rates too early or too quickly without sufficient evidence that inflation is on a sustainable and timely path,” said Loretta Mester, president of the Federal Reserve Bank. of Cleveland, in a press release. a recent speech. This point was echoed by other officials, including Christopher Wallera Fed governor.

Fed officials have another political project to accomplish in March: They indicated they will discuss their future plans for their bond balance sheet. They have reduced their balance sheet by allowing securities to expire without reinvestment, a process that takes some of the momentum out of markets and the economy at the margins.

The Fed's balance sheet expanded during the pandemic as it purchased bonds in large quantities, first to calm markets and then to stimulate the economy. Authorities want to bring it back to more normal levels to avoid playing such a large role in financial markets. At the same time, they want to avoid overdoing it by reducing their bond holdings to the point of risking market disruptions.

George Goncalves, head of U.S. macro strategy at MUFG, said he thinks officials would first want to develop a plan to slow the balance sheet runoff and then turn to rate cuts. He thinks the first rate cut could come in June or July.

Michael Feroli, chief US economist at JP Morgan, expects a rate cut in June – and said he doubts the argument that it could prove more difficult to finish the job on inflation than starting it. He thinks falling labor costs and housing inflation will continue to slow price increases.

“We might be getting a little nervous,” Mr. Feroli said. The idea that the “last mile” will be more difficult “has a nice rhetorical appeal, but then you kind of scratch it, and I wasn’t convinced.” »

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