They could start counseling on Jan 31-Feb. 1 to determine how much more weakening in labor demand, spending and inflation they need to see before pausing rate hikes this spring.
In recent public statements and interviews, Fed officials have said that slowing the pace of rate hikes to a more traditional quarter of a point would give them more time to assess the impact of their hikes, as far as determining where to stop.
Officials drew attention to how long it will take for the full effects of higher interest rates to cool economic activity as they retreated to a half-point hike in December after four consecutive 0.75-point hikes.
“And that logic is very applicable today,” Fed Vice Chair Lael Brainard said in a comment last week. Raising interest rates in smaller increments “gives us an opportunity to absorb more data…and probably do a better job of ending up at sufficiently restrictive levels.”
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To combat high inflation, the Fed last year carried out the fastest series of interest rate hikes since the early 1980s, raising its benchmark interest rate on federal funds by 4.25 percentage points. A quarter point hike next month would put the rate in a range between 4.5% and 4.75%.
Most Fed officials forecast that interest rates would rise to a peak of between 5% and 5.25% in December. That would mean two more quarter-point increases after the likely rise next month. According to CME Group, investors in the interest rate futures markets expect the Fed to hike two more quarter points – at the upcoming Fed meeting and again at the following mid-March Fed meeting.
The Fed raised interest rates seven times in the past year. The likely decision to approve a smaller hike in February reflects officials’ growing confidence that the economy is responding to their efforts to contain demand and bring down inflation.
In recent weeks, government data and business surveys have pointed to a sharper fall in manufacturing activity and new orders for service firms, as well as a fall in consumer spending on goods.
The central bank’s rate hikes are aimed at slowing inflation by reducing demand, “and there’s ample evidence that this is what’s happening in the corporate sector,” said Fed Governor Christopher Waller, who said early last year and had been vocal about aggressive rate hikes,” he said on Friday. Mr Waller said he would support a quarter-point rate hike at the upcoming meeting.
The Commerce Department is due this week to release December numbers for the Fed’s preferred measure of inflation, the Personal Consumption Index. Excluding food and energy prices, the so-called core PCE index was likely up 4.5% year-on-year in December and at a three-month annual rate of 3.1%, Ms Brainard said.
Officials could use their statement after the Feb. 1 meeting to indicate they expect to continue raising interest rates while they consider where to stop. But they are unlikely to give precise clues as upcoming decisions will depend heavily on new data on the economy.
Some have also indicated that even if they hold rates steady this summer, they will announce that they will be raising rather than lowering rates. After the Fed’s pauses, “we need to remain flexible and keep raising rates if changes in the economic outlook or in financial conditions call for it,” Dallas Fed Chair Lorie Logan said in a recent speech.
At the upcoming meeting, officials could discuss two key questions: How long before the full impact of the Fed’s rate hikes affects hiring and aggregate demand? And by how much could inflation slow down due to other factors, such as B. reducing bottlenecks in the supply chain or lower costs for fuel and other raw materials?
Some could call for any pause to be postponed unless the economy weakens sharply in the coming months. They believe that the time between the Fed raising rates and the economy slowing is relatively short and the economy will soon feel the worst of a policy-induced slowdown.
Others might argue for a slightly earlier break, believing the effects last longer or might be stronger.
Federal Reserve Chair Jerome Powell announced a 0.5 percentage point rate hike in mid-December and said the Fed expects further hikes to be appropriate. Photo: Al Drago/Bloomberg News
Divisions have emerged. James Bullard, President of the St. Louis Fed, recently said he would prefer a steeper half-point hike at the next meeting, believing rates are not high enough to thoroughly beat inflation. “You’d probably have to get over 5% to be able to say seriously that we’re at the right level,” he said in an interview. “Why not go where we’re supposed to go? … Why hold off and not quite get to that level?”
Several of his colleagues have advocated more flexibility to see if easing pandemic and war-related disruptions allows inflation to fall faster. As there is mounting evidence that higher interest rates are working as intended, “why would we try to … really relieve the economy and really risk losing the good things that we have, like the job market?” That said the president the Philadelphia Fed, Patrick Harker, last week. “I just don’t see that.”
Fed officials have long expected inflation to fall as supply chain shortages and disruptions in commodity markets ease, but inflation instead rose in the first half of 2022 before moving sideways, according to the Commerce Department.
Inflation has declined over the past three months, mainly due to falling fuel prices and commodity prices such as used cars. There are signs that rents and other housing costs will fall markedly on the back of a sharp fall in demand, although this is unlikely to be reflected in official inflation measurements until later this year.
As a result, Fed Chair Jerome Powell and several colleagues have recently shifted their focus to a narrower subset of labor-intensive services, excluding food, energy, housing and commodity prices. Inflation in this category was around 4.4% on both a 12-month and a three-month basis, compared to an average of around 2.3% between 2010 and 2019.
Officials believe this category could shed light on whether higher labor costs are feeding through to consumer prices.
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If services inflation is high because paychecks are rising in step with prices, as was the case in the 1970s, then Fed officials would want to see a slower hiring.
But if price increases for services like restaurant meals, car insurance and airfares instead reflect the ripple or “passage through” effects of some of the global dislocations that are now reversing, services inflation could ease faster and without such a significant weakening in labor markets.
The recent slowdown in inflation, coupled with the lagged impact of Fed rate hikes that could further slow the economy, “may provide some reassurance that we are not currently witnessing a 1970s-style wage-price spiral,” Ms Brainard said.
Fed officials last month revised upwards their forecasts for this year’s inflation, in part on concerns that wage growth would be too high. Signs that wage growth has been slowing since then could play an important role in the debate over how soon to pause.
Officials have two months before their March 21-22 meeting to see several widely watched economic indicators, including attitudes and inflation. They’re paying close attention to a detailed measure of workers’ compensation, called the Employment Cost Index, due to be released on January 31.
The report may provide further confirmation that wage growth slowed late last year.
Write to Nick Timiraos at [email protected]
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