Federal Reserve officials were busy this week delivering speeches, speaking with the media, and penning essays to inform the financial markets that monetary policymakers might not be so fast to cut interest rates as they were to raise them.
Caution Ahead; More Confidence Needed
Fed Gov. Adriana Kugler said several signs indicate progress on inflation: moderating wage growth, surveys showing a slower pace in price hikes, and how often companies are boosting consumer prices.Despite these signals, Ms. Kugler echoed the sentiment of her colleagues by seeking more confidence before pulling the trigger on a rate reduction. She told a Brookings Institution event on Feb. 7 that the FOMC’s “job is not done yet,” even as the data allude to various disinflation trends throughout the economy.
“At some point, the continued cooling of inflation and labor markets may make it appropriate to reduce the target range for the federal funds rate,” she said in her prepared remarks. “On the other hand, if progress on disinflation stalls, it may be appropriate to hold the target range steady at its current level for longer to ensure continued progress on our dual mandate.”
The Fed official refrained from sharing about when she thinks the central bank could begin lowering interest rates, noting that “every meeting is live” and that she and her colleagues will rely on the data.
More Confidence Wanted
Thomas Barkin, president of the Federal Reserve Bank of Richmond, also conveyed the need for more confidence before he is convinced to start slashing rates from their 23-year high.
Appearing before the Economic Club of New York, he said in prepared remarks that he is searching “for more conviction” that slowing inflation is “broadening and sustainable.”
“Given robust demand and a historically strong labor market, we have time to build that confidence before we begin the process of toggling rates down,” Mr. Barkin said.
He refrained from declaring victory and listed “two reasons for caution.”
The first is that “the plane has not landed yet.” Despite the White House claiming that the U.S. economy has achieved a soft landing, the Fed has refused to make this declaration, including Mr. Barkin. He explained that there have been “many stories of inflation head-fakes,” particularly at the end of former Fed Chair Paul Volcker’s era.
“Inflation seemed to settle in mid-1986,” Mr. Barkin said. “The Fed reduced rates. But inflation then escalated again the following year, causing the Fed to reverse course. I would love to avoid that roller coaster if we can.”
From the 1970s to the early 1990s, the Consumer Price Index (CPI) ebbed and flowed, leading the central bank to hike and cut repeatedly until conditions settled down by 1993.
The second reason for caution is the focus on fundamentals and how inflation and the COVID-19 pandemic might have permanently altered the U.S. economy.
Time Is on the Fed’s Side
Because the U.S. economy is on solid ground and the labor market is intact, the policymakers have been afforded enough time before cutting rates, according to Minneapolis Fed President Neel Kashkari.
In an essay Mr. Kashkari wrote, “Policy Has Tightened a Lot. How Tight Is It?” published on the regional central bank’s website, he noted that monetary policy might not be as restrictive on economic growth as the data suggest. In other words, the so-called long-term neutral rate—a neither stimulative nor restrictive policy—might not be as tight, and the current rate could stay the same without harming the economy.
“This constellation of data suggests to me that the current stance of monetary policy, which, again, includes the current level and expected paths of the federal funds rate and balance sheet, may not be as tight as we would have assumed given the low neutral rate environment that existed before the pandemic,” he wrote.
As a result, FOMC members will have enough time before launching the process of lowering interest rates “with less risk that too-tight policy is going to derail the economy recovery.”
In the fourth quarter of 2023, the U.S. economy expanded by 3.3 percent, following a real GDP growth rate of 4.9 percent in the third quarter.
During a Feb. 7 interview with CNBC, Mr. Kashkari projected that “two to three rate cuts would seem appropriate for me right now.”
“That’s my gut based on the data we have so far,” he told the business news broadcaster, noting that it is vital to be guided by the inflation data.
If the inflation metrics continue to be “resoundingly positive” then the discussion can be at what speed the FOMC start adjusting rates back down, according to Mr. Kashkari.
What the Market Says
According to the CME FedWatch Tool, investors have priced in a 60 percent chance of a rate cut in May.Before last month’s FOMC meeting, traders were confident that the Fed would begin cutting rates as early as March. However, after Mr. Powell’s press conference remarks and an interview with CBS’s “60 Minutes,” economists have started discussing that the central bank may be “less proactive.”
“I continue to believe the Fed will be less proactive and wait for the data to scream cut from the rafters,” Jeff Klingelhofer, co-head of investments at Thornburg Investment Management, said in a note. “Cutting preemptively merely on the back of falling inflation or without a notable weakening of labor markets isn’t how the Fed will play its hand.”
Until the next two-day FOMC meeting in March, there will be plenty of data to assess, including two CPI reports and more jobs data.
After unexpectedly ticking up last month to 3.4 percent, the Cleveland Fed’s Inflation Nowcasting model expects the next CPI reading to ease to 3 percent and core CPI, which strips the volatile energy and food components, to dip to 3.8 percent.
Mr. Powell has said that he wants to see inflation sustainably at the 2 percent target rather than touching it just once and then moving back up.
