WASHINGTON — Chairman Jerome Powell will enter this week’s Federal Reserve meeting in a much more desirable position than he probably ever expected: inflation is approaching the Fed’s target, the economy is still growing at a healthy pace, consumers continue to spend and the unemployment rate is near a half-century low.
A year ago, most economists had a much bleaker picture in mind. As the Fed raised rates at the fastest pace in four decades to combat high inflation, most economists warned of a recession, possibly a painful one, with waves of layoffs and rising unemployment. Even the Fed’s own economists had predicted that the economy would enter a recession by 2023.
The unexpectedly rosy picture — one that is sure to be the subject of heated debate during the 2024 presidential race — may have left some Fed officials with uncertainty. With their frameworks for assessing the economy upended by the pandemic and its aftermath, it is difficult to say whether the healthy conditions of the economy can hold.
“It almost feels like what we saw in the second half of last year was too good to be true,” said Nathan Sheets, chief economist at Citi and a former Fed economist. “When things are too good to be true, you want to try to scratch the surface and say, how sustainable is this?”
Some Fed officials have raised similar questions and expressed caution about their next steps. When they last met in December, the 19 Fed policymakers who participate in rate decisions said they expected to cut their benchmark interest rate three times this year. Still, the timing of these interest rate cuts, which would lead to lower borrowing costs for consumers and businesses, remains uncertain.
Most economists say they expect the first rate cut to come in May or June, although a cut at the March Fed meeting is not yet off the table. The timing of the rate cuts will almost certainly be the main topic at the Fed’s two-day meeting, which ends Wednesday. The Fed will almost certainly announce after the meeting that it will leave its key rate unchanged at around 5.4%, where it has been since July, a 22-year high.
The central bank’s consideration of rate cuts will come against the backdrop of an intensifying presidential campaign as President Joe Biden seeks re-election amid a polarizing issue on the economy. Rate cuts could provoke an attack from former President Donald Trump, who nominated Powell as Fed chairman but later publicly criticized him for raising rates during Trump’s presidency and demanded he cut them.
At a press conference last month, Powell said: “We don’t think about politics. We think about what is the best thing to do for the economy.”
On Wednesday, Fed policymakers could signal they are about to cut rates by adjusting the wording in the statement they issue after each meeting. In December, the statement still suggested officials were willing to consider further rate increases. Removing or changing this wording in next week’s statement would signal that they are moving to a new approach focused on interest rate cuts.
The Fed’s aggressive series of 11 rate hikes, which began in March 2022, was aimed at curbing inflation, which peaked at 7.1% in June 2022, according to the central bank’s preferred gauge. But data released Friday shows that inflation has fallen all the way back to the Fed’s annual target level of 2% over the past six months. Over the past three months, annual inflation, excluding volatile food and energy costs, has fallen to just 1.5%.
Still, Fed officials are expected to wait at least a few months, trying to build confidence that inflation has truly been defeated, before cutting rates.
Christopher Waller, an influential member of the Fed’s board of governors, sounded a note of caution in a recent speech.
“2% inflation is our target,” he said. “But that goal cannot simply be achieved. It must be sustained.”
Waller has previously referred to being “faked” about inflation. On more than one occasion, when initial government reports had indicated that inflation was falling, subsequent revisions of the data showed that price increases actually remained high. In his speech, Waller identified the government’s upcoming revisions to inflation data, due to be released on February 9, as a report he will be closely watching.
It is possible that inflation will remain undesirably high, especially if the economy remains strong, which could lead the Fed to leave rates unchanged. Fed officials have said that as long as the economy remains healthy, it could take some time before interest rates are cut.
Average salaries are still rising at about 4% to 4.5% per year, and apartment rents are still rising faster than before the pandemic. Officials expect rents to cool as a slew of new apartment buildings are completed. But that remains to be seen from the official data. And some prices in the service sector, such as those for restaurant meals, are still rising.
“We would say we’re not out of the woods yet,” said Tiffany Wilding, director and economist at PIMCO. “The Fed doesn’t want to be Arthur Burns,” she added, referring to the 1970s Fed chairman who is widely blamed for cutting rates too quickly, causing inflation to become more deeply entrenched in the economy .
At the same time, the Fed is grappling with a similar risk in the other direction: that it could keep policy rates too high for too long and potentially trigger a recession. Consumers spent their money at a healthy pace during the last three months of last year, but may eventually pull back due to higher borrowing costs and prices that are still well above three-year levels.
“They run the risk of exaggerating their high interest rates and slowing the economy in a way that really isn’t necessary,” said Bill English, a professor of finance at the Yale School of Management and a former Fed economist.
Still, the Fed could also accelerate its rate cuts later this year if the economy weakens, just as it quickly raised rates after waiting too long to start raising them in 2022, says Claudia Sahm, founder of Sahm Consulting and a former Fed -economist.
“I fully expect they will wait as long as humanly possible to cut rates,” she said. “The Fed excels at catching up.”