Federal Reserve is likely to preach patience as consumers and markets look ahead to rate cuts

WASHINGTON — In the United States, many people are eagerly awaiting the first interest rate cut by the Federal Reserve this year: potential home buyers are hoping for lower mortgage rates. Wall Street traders anticipate higher stock prices. Consumers are looking for a solution to their credit card debt at record high interest rates.

Not to mention President Joe Biden, whose re-election campaign would likely benefit from an economic shock from lower interest rates.

Still, Chairman Jerome Powell and his fellow Fed officials are expected to play it safe this week, keeping rates unchanged for the fifth time in a row and signaling that they still need further evidence that inflation is sustainably returning to their target of 2%.

The Fed’s cautious approach illustrates what’s unusual about this round of potential rate cuts. Vincent Reinhart, chief economist at Dreyfus-Mellon and former Fed economist, notes that the Fed typically cuts rates quickly when the economy worsens, in an often futile attempt to prevent a recession.

But this time the economy is still healthy. The Fed is considering rate cuts only because inflation has been steadily declining from a peak of 9.1% in June 2022. As a result, it is approaching rate cuts the way it usually does rate hikes: slowly and methodically, while trying to change the direction of the economy predictable. from often contradictory data.

“The Fed drives events, not events drive the Fed,” Reinhart said. “That’s why this job is different from others.”

Central bank policymakers had said after their last meeting in January that they needed “more confidence” that inflation was definitely cooling towards their 2% target. Since then, the government has released two inflation reports showing that the pace of price increases remains high.

In most respects, the U.S. economy remains remarkably healthy. Employers continue to hire, unemployment remains low and the stock market is hovering around record highs. Yet average prices remain much higher than before the pandemic — a source of unhappiness for many Americans for which Republicans have tried to blame Biden.

Excluding volatile food and energy costs, so-called “core prices” rose at a monthly pace of 0.4% in both January and February, a pace far higher than consistent with the Fed’s inflation target. Compared to a year earlier, core prices rose by 3.8% in February. Core prices are considered a signal of where inflation is likely to go.

But in February, a measure of housing costs slowed, a notable trend because housing is among the “strongest” price categories the government tracks. At the same time, more volatile categories such as clothing, used cars and airline tickets drove up prices in February and could see a reversal in the coming months.

“Nothing about these two data prints made you feel substantially better about” inflation soon reaching the Fed’s target, said Seth Carpenter, chief economist at Morgan Stanley and also a former Fed economist. “But it’s not at all enough to change your mind about the fundamental direction of travel” for inflation.

Several Fed officials have said in recent speeches that they expect inflation to continue to decline this year, although likely more slowly than in 2023.

The Fed has also built in some expectations that price increases will only gradually decline this year. In December, core inflation was forecast to reach 2.4% by the end of 2024. That’s not far from the current 2.8%, according to the Fed’s preferred benchmark.

On Wednesday, Fed policymakers will update their quarterly economic forecasts, which are expected to repeat their December forecast for three rate cuts by the end of 2024. Still, it would only take two of the nineteen Fed officials to change their forecast to one less. The central bank’s general expectation is that interest rates will be cut to just two cuts in 2024. Some economists expect this to happen as inflation has remained stubborn early this year.

The Fed’s policy rate stands at about 5.4%, the highest level in 23 years, after a series of 11 rate hikes that were aimed at curbing the worst inflation in four decades but have also made borrowing much more expensive for consumers and businesses.

Like the Fed, other major central banks are keeping interest rates high to ensure they can keep spikes in consumer prices under tight control. In Europe, pressure is increasing to reduce borrowing costs as inflation falls and economic growth has stalled, unlike in the United States. The leader of the European Central Bank hinted this month that a possible rate cut would not come until June, while the Bank of England is not expected to open the door to an imminent cut at its meeting on Thursday.

Most economists expect the Fed to make its first rate cut at its June meeting, which would mean the Fed would signal such an upcoming move in May. By June, policymakers will have three more inflation data and three more jobs reports in their hands.

Sarah House, senior economist at Wells Fargo, said the timetable leaves plenty of time for inflation to resume its downward path. An interest rate cut would likely lead to lower rates over time on mortgages, car loans, credit cards and many business loans.

“They definitely need to see something better than the last few months, but they can get it,” she said.