The Fed is likely to raise interest rates and signal a pause in the inflation battle
Here’s the good news.
After the most aggressive rate hikes in 40 years, the Federal Reserve is expected on Wednesday to approve a final quarter-point increase and signal a long-awaited pause, economists say.
The prospect of interest rate rises ending should be a welcome relief for consumers and businesses struggling with higher borrowing costs. And it could ease the worries of investors hit by the market-dampening fallout from the 13-month rate hike campaign. Any sign of a halt will come sooner than expected and underscore that the recent failures of Silicon Valley Bank and Signature Bank have acted as a kind of rate hike by dampening lending, economic growth and, most critically, inflation.
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Now, the not so good news.
The Fed has no plans to unfurl a “Mission Accomplished”[ads1]; banner. It is expected to say it is prepared to raise interest rates further if inflation and the labor market do not cool as projected. And the central bank is likely to emphasize that it does not plan to cut interest rates this year, as markets predict, even in the event of a widely predicted recession. Fed officials do not expect interest rate cuts until 2024.
“They are not afraid of having a shallow recession,” says Barclays economist Jonathan Millar. “They want to avoid causing a deep recession.”
Will the Fed raise interest rates again this year?
In other words, the Fed is likely to signal that while it is on hiatus, it is ready to raise or lower interest rates this year, but it is more likely that it will raise them, Millar says.
Economists expect the Fed to remove guidance in its March post-meeting statement that “some additional (rate hikes) may be appropriate” to bring inflation down to the Fed’s 2% target. Instead, Goldman Sachs expects the central bank to say interest rates are likely to be enough to achieve that target, but the Fed will closely monitor economic data to determine the next rate moves.
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Such a strategy would not come as a surprise. In March, the Fed predicted it would raise its key interest rate by another quarter to a range of 5% to 5.25% and then wind down its inflation-fighting measures, which have lifted the benchmark interest rate from near zero in early 2022.
Recent economic data paint a mixed picture of inflation. A government report last week revealed the Fed’s preferred gauge of inflation fell to 4.2% last month from a 40-year high of 7% last June. But an underlying “core” measure that strips out volatile food and energy items remained higher than forecast at 4.6%.
A barometer of wage growth also showed U.S. workers’ wages and benefits rose 1.2% in the first quarter, topping the fourth-quarter pace and economists’ estimates. Companies often pass on higher labor costs to consumers through higher prices.
What could cause the Fed to raise interest rates again?
“We believe a June increase is back on the table if inflation gains stall along with continued strong employment gains in May,” Barclays wrote in a research note.
The Fed expects annual core inflation to fall to 3.6% by the end of the year, according to its March forecast. That would require monthly rate increases to average less than 0.3%, Barclays says. If data over the next few weeks show inflation exceeding that pace, “there could be grounds for another increase,” the research firm said.
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Correspondingly, monthly job growth has slowed from 472,000 in January to 236,000 in March. If May payrolls increase by 200,000, it could also lead to the Fed raising interest rates in the coming months, Barclays says.
However, Morgan Stanley also notes that such developments “must be weighed against information about bank lending and its economic effects.” Simply put, if the banking crisis constrains borrowing and the economy more than expected, the Fed will have to balance the opposing forces.
“It’s a difficult proposition,” says Millar.
Why would the Fed cut interest rates?
Barclays says interest rate cuts this year “are highly unlikely unless a broad financial crisis or a very significant external shock hits the economy”.
Barclays expects a recession starting in the second half of the year to lead to the loss of around 800,000 jobs and push the unemployment rate from 3.5% to 4.9% by early 2024.
That’s a milder-than-average decline, Millar says, adding that it will take a more severe decline to get the Fed to cut rates this year.
“We think a moderate recession will play out (later this year), but the Fed will not be able to respond by cutting rates as inflation will remain high and sticky,” said Kathy Bostjancic, chief economist at Nationwide Mutual.
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