Federal Reserve officials are expected to leave interest rates unchanged at their meeting on Wednesday, giving themselves more time to assess whether borrowing costs are high enough to weigh on the economy and bring inflation under control.
But investors will likely focus less on what policymakers do on Wednesday – and more on what they say about the future. Wall Street will be watching closely to see whether Fed policymakers expect another rate hike before the end of the year or whether they are moving toward the next phase in the fight against rapid inflation.
Central bankers have already raised interest rates to 5.25 to 5.5 percent, the highest level in 22 years. By making it more expensive to borrow money to buy a home or expand a business, they try to curb demand throughout the economy, making it harder for companies to charge more without losing customers and slowing price increases.
In their last quarterly economic forecast, released in June, officials predicted they would likely raise rates again before the end of 2023. They maintained this option throughout the summer, even as inflation began to decline significantly. But key policymakers appeared less eager in recent weeks to take another step.
Fed Chairman Jerome H. Powell suggested in June that another adjustment was “likely.” Recently, including during a widely watched speech in August, he said that policymakers could raise interest rates “if appropriate.”
Fed officials will release economic forecasts after their meeting this week on Tuesday and Wednesday, taking a fresh look at whether most policymakers still believe a final rate hike is likely necessary. The forecasts will also show how officials interpret a confusing moment in the economy in which consumer spending was stronger than many economists expected even as inflation cooled slightly faster.
Taken together, the revised forecasts, the Fed’s statement and a post-meeting news conference with Mr. Powell could provide the clearest signal yet about how close it believes the central bank is to the end of rate hikes – and what the next phase of attempts might be look like fighting inflation completely.
“Many centrist Fed officials have said in recent weeks: We’re close to where we need to be – maybe we’re even there,” said Michael Feroli, chief U.S. economist at JP Morgan.
Mr. Feroli believes there is about a two-thirds chance that policymakers will still predict another rate hike and a one-third chance that they will predict that the current situation is likely to be the maximum interest rate.
But even as the Fed signals that interest rates have peaked, officials have made clear they are likely to remain elevated for some time. Policymakers believe that simply keeping interest rates high will continue to weigh on economic growth and the economy will gradually cool.
Mr Feroli doesn’t yet expect officials to be too decisive about the next phase – a phase in which interest rates will be cut.
“They haven’t won the war on inflation, so it would be a little premature,” Feroli said.
However, the economic forecasts could provide some clues. Fed officials will release their forecasts for interest rates in 2024, 2025 and, new, 2026 after this meeting. In June, officials had expected to cut borrowing costs four times next year in their 2024 forecasts. The question is when this year those cuts would occur and what officials would need to consider to feel comfortable about cutting interest rates.
Policymakers may provide little clarity on these points Wednesday, hoping to avoid a major market reaction — one that would complicate their task of cooling the economy.
If stock prices soared while markets generally believed that the Fed-induced financial and economic crisis was likely to end sooner, it could become cheaper and easier for businesses and households to borrow money. That could stimulate the economy while the Fed tries to slow it down.
Growth has already withstood the Fed’s high interest rates surprisingly well. Consumers and businesses have continued to keep spending at healthy levels despite the many economic risks in the outlook – including the resumption of federal student loan repayments in early October and a possible government shutdown after the end of this month.
Household savings left over from the pandemic, a strong labor market with solid wage growth and various government measures to encourage investment in infrastructure and green energy could help fuel this dynamic.
The resilience could lead to another revision to the Fed’s economic forecasts on Wednesday, Goldman Sachs economists said: Officials could raise their estimate of the so-called neutral interest rate, which signals how high interest rates need to be to weigh on the economy. That would suggest that while policymakers are slowing the economy today, they are not doing so quite as much as officials would have expected.
The economy’s staying power could also prevent policymakers from sounding too excited about the recent slowdown in inflation.
The rise in the consumer price index has moderated significantly over the past year – to 3.7 percent in August, down from 9.1 percent at its peak in 2022 – as pandemic-related disruptions ease and prices of goods that were in short supply fall or fall rise more slowly.
The Fed’s preferred inflation gauge, which is released with a longer lag than the consumer price index, was expected to have risen slowly on a monthly basis in August after stripping out food and fuel prices to provide a clearer picture of the inflation trend.
The slowdown is undoubtedly good news – it makes it more likely that the Fed could slow the economy just enough to temper price increases without slowing the economy. But policymakers may worry about completely stamping out inflation in an economy that is still growing robustly, said William English, a former Fed economist who is now a professor of financial practice at Yale.
If consumers are still willing to spend money, companies may find that they can still raise prices to pad or protect their profits. Given this, officials may think that a more significant economic slowdown is needed to bring inflation all the way down to their 2 percent target.
“The economy remained stronger for longer than expected,” Mr. English said. With that in mind, Fed officials may argue that their next move is more likely to be a rate hike than a rate cut.
Mr. English is skeptical that Fed officials believe they can fully moderate price increases without causing a further economic slowdown.
“I doubt that they are anticipating flawless inflation control, which is their most likely forecast,” he said. “I think that’s still their base case: the economy really needs to go through a period of fairly slow growth.”