When will Fed cut rates? As US economy flexes its muscles, maybe later or not at all

WASHINGTON — Ever since the Federal Reserve signaled last fall that it was likely done raising interest rates, Wall Street traders, economists, car buyers and potential homeowners — virtually everyone — have begun to obsess over a single question: When will the Fed start lowering interest rates?

But with the US economy proving surprisingly strong, another question has arisen: Will the central bank really cut interest rates three times this year, as the Fed itself has predicted – or even cut them altogether? The Fed typically only makes cuts when the economy appears weakened and in need of help.

Lower interest rates would lower financing costs for homes, cars and other big purchases and likely fuel higher stock prices, all of which could help accelerate growth. An even more robust economy could also benefit President Joe Biden’s re-election campaign.

Friday’s successful March jobs report reinforced the idea that the economy is doing just fine on its own. The government said employers added a huge boom in jobs last month — more than 300,000 — and the unemployment rate fell from 3.9% to a low 3.8%.

Some analysts responded by arguing that it is clear that the last thing the economy needs right now is more stimulus from lower interest rates.

“If the data is too strong, why are we cutting?” asked Torsten Slok, chief economist at Apollo Global Management, an asset management firm. “I don’t think the Fed will cut rates this year. Higher (rates) and longer is the answer.”

In March, central bank policymakers – as a group – had planned three rate cuts by 2024, as they did in December. Some economists still expect the Fed to make its first rate cut in June or July. But even last month’s Fed meeting had exposed some cracks, with nine of 19 policymakers predicting just two rate cuts or fewer before 2024.

Since then, Friday’s jobs data, combined with an unexpectedly positive report showing factory output picking up again after months of contraction, suggested the economy is continuing an unexpected streak of healthy growth. Despite the Fed’s aggressive series of rate hikes in 2022 and 2023, which pushed up mortgage rates and other borrowing costs, the economy is defying long-standing expectations that it would weaken.

Such trends have made some Fed officials nervous. Although inflation has fallen sharply from its peak, it remains stubbornly above the Fed’s 2% target. Rapid economic growth could reignite inflationary pressures, reversing the progress made.

In a series of speeches over the past week, several Fed officials emphasized that there was little need to cut rates anytime soon. Instead, they said, they need more information about where exactly the economy is headed.

“It’s far too early to think about cutting rates,” Lorie Logan, president of the Federal Reserve Bank of Dallas, said in a speech. “I’ll need to see more of the uncertainty resolved about what economic path we’re on.”

Raphael Bostic, head of the Atlanta Fed, said he was in favor of just one rate cut this year – and only in the last three months. And Neel Kashkari, chairman of the Minneapolis Fed, sent stock prices tumbling Thursday afternoon after raising the possibility that the Fed might not make any cuts at all this year.

“If we continue to see strong job growth,” Kashkari said, “if we continue to see strong consumer spending and strong GDP growth, then that begs the question for me: Why would we cut rates?”

Still, a strong economy and hiring alone won’t necessarily prevent rate cuts. Chairman Jerome Powell and other officials, such as Cleveland Fed President Loretta Mester, have underscored that the key factor in the Fed’s rate cut decision is when — and if — inflation will return to the central bank’s 2% target . . They note that the economy managed to grow strongly in the second half of 2023, even as inflation fell steadily. By the Fed’s preferred measure, inflation is now just 2.5%, down from a peak of 7.1%.

Still, core prices — which ignore volatile food and energy costs — rose faster than in line with the Fed’s target in January and February, raising concerns that inflation has not yet been fully contained.

As a result, the government’s upcoming reports on inflation will be closely scrutinized for signs that inflation is easing further. Wednesday’s report on the consumer price index is expected to show that core prices rose 0.3% from February to March, which is generally too fast for the Fed’s liking.

One reason Powell suspects the economy can continue to grow even if inflation cools is that the supply of labor has surged over the past two years. This trend makes it easier for the economy to produce more and avoid shortages, even if demand remains strong. It also helps keep wage and price growth in check.

A surge in immigration over the past two years, much of it unauthorized, has dramatically increased the number of workers willing to fill jobs. Their entry into the labor market has largely reversed labor shortages that plagued the post-pandemic economy and caused wages to rise for workers in retail, restaurants and hotels.

“There are significantly more people working,” Powell said in a discussion at Stanford University this week. “It’s a bigger economy, rather than a tighter one.”

Whether the trend of increasing labor supply can continue this year will partly determine what next steps the Fed will take.

Yet even Powell acknowledged last month at a Fed conference in San Francisco that the healthy economy reduces the urgency of rate cuts: “This economy does not feel like it is suffering from the current level of interest rates.”

Slok and some Fed officials believe that borrowing costs are not holding back the economy as much as they might have in the past. That’s because in today’s economy, several trends could keep growth, inflation and interest rates higher than they have been in the past twenty years. These include a more productive economy, larger government budget deficits, and the return of some manufacturing from abroad to the United States, where it is more expensive.

“It is extremely difficult to argue that the Fed should cut rates at all – and the debate about raising rates again should perhaps be more lively than it is now,” said Thomas Simons, an economist at Jeffries, a real estate agency.