Investors do not expect the Federal Reserve to raise interest rates again, and officials have made clear that they consider further increases unlikely. But an important takeaway from the Fed’s recent comments is that improbable and inconceivable are not the same thing.
After the central bank held rates steady at 5.3 percent last week, Federal Reserve Chairman Jerome H. Powell held a news conference in which what he didn’t say mattered.
When asked whether officials might raise interest rates again, he said he thought they probably wouldn’t, but also avoided completely ruling out the possibility. And when asked, twice, if he thought rates were high enough to completely control inflation, he twice tiptoed around the question.
“We think it’s restrictive and we think over time it will be restrictive enough,” Powell said, but added a critical caveat: “That’s going to be a question the data is going to have to answer.”
There was a message in that dodge. While officials are more inclined to keep interest rates at their current levels for a long time to control inflation, authorities could be open to higher interest rates if inflation were to rise again. And Federal Reserve officials have made that clear in interviews and public comments over the past few days.
Neel Kashkari, president of the Federal Reserve Bank of Minneapolis, said Tuesday that he was cautious about a scenario in which inflation stagnates at its current level, and hinted that it’s possible rates could rise further.
Michelle Bowman, a Federal Reserve governor who tends to favor higher interest rates, has said she remains “willing to raise” borrowing costs if progress in reducing inflation remains stagnant or reverses. And Thomas Barkin, president of the Federal Reserve Bank of Richmond, said he thought rates were weighing on the economy, but that “time will tell” whether they were doing so enough.
Officials still strongly expect the economy to slow given today’s rate setting, which they believe is weighing on demand by making it more expensive for businesses to borrow money to expand and for households to buy on credit. While progress in reducing inflation has stalled lately, Fed policymakers have made clear that the most likely outcome at this stage is that they will simply keep interest rates at the current level for some time to gradually slow the decline. growth and cause price increases. to its 2 percent target.
Officials have also said that while in 2022 and 2023 they were determined to reduce inflation even if doing so came at a high economic cost, they are now taking a more careful approach. Inflation has dropped sharply from its 2022 highs. In light of moderation, quickly reducing inflation is less urgent for the Federal Reserve, so officials are free to act cautiously and try to avoid causing a recession.
But as Fed officials prepare for a pause as they wait for their policy to squeeze the economy enough to beat rapid price increases, that stance could change. If inflation starts to cool decisively again, they hope to cut rates. And if inflation surprises them by rising again, rate increases are still possible.
Fortunately for anyone hoping for lower rates on credit cards, cars or mortgages (and hoping that borrowing costs don’t skyrocket further), most economists do expect inflation to slow in the coming months, and essentially none expect it to increase.
Inflation has stalled in recent months after falling sharply last year, in part because housing costs have proven surprisingly persistent and because insurance costs have risen. But economists in a Bloomberg survey think that could change starting next week: New Consumer Price Index data is expected to show headline inflation fell to 3.4 percent in April, down from 3. .5 percent in March.
By the end of the year, economists expect that measure to drop to 2.9 percent. In fact, not a single economist in another Bloomberg survey expected it to be above its current level by the final quarter of 2024. And the Fed’s preferred inflation index, the Personal Consumption Expenditure Index, is expected to be even lower, 2.5 percent.
“Everyone is more or less in the same camp, but I think it’s for good reasons,” said Gennadiy Goldberg, rates strategist at TD Securities, noting that economists are fairly confident that rent inflation will slow and that insurance prices should eventually moderate.
“The level of confidence is quite high that inflation will come down by the end of the year,” he said. “The question is whether it will come down fast enough or soon enough for the Fed to cut rates this year.”
That prospect of cooler inflation explains why investors also generally expect interest rates to fall, not rise, in the coming months. Markets have sharply reduced their expectations of multiple rate cuts this year, but see a strong possibility of one or two reductions by the end of the year. They basically see no chance of a rate hike.
But although almost no one expects it, there is always the risk that inflation will rise again. Geopolitical issues could drive up gasoline prices, which could then affect other products and services such as airfares. Or – more worryingly for the Federal Reserve – the economy could recover, allowing companies to raise prices for goods and services more quickly.
That second scenario appears to be what officials are paying attention to, and some have suggested that they would be open to raising borrowing costs if they were convinced that current interest rate levels were not doing enough to slow growth and prices.
“If we needed to keep rates where they are for an extended period of time to slow the economy, or if we even had to raise them, we would do whatever it takes to bring inflation back down,” Kashkari said. he said Tuesday.
The result? Investors, economists and Fed officials themselves generally expect that the central bank’s next move will be to cut interest rates. But that is because they are confident that inflation is about to go down. If that perspective turns out to be wrong, things could change.