The Federal Reserve is poised to take another dramatic step this week to curb alarmingly high inflation, but the US central bank’s strategy beyond that point is less certain as another spike in consumer price growth weighs in against rising inflation. recession risks.
The Federal Open Market Committee will confirm market expectations on Wednesday and raise key interest rates by 0.75 percentage point for the second month in a row. That will raise the Federal Funds rate to a new target range of 2.25 percent to 2.50 percent, in line with officials’ long-term estimates of a “neutral” policy institution.
A series of rate hikes are planned after July, but with signs of consumer distress emerging and cautious predictions that the worst of the recent inflation shocks may be over, the Fed now faces an increasingly difficult task in deciding how to realign its path forward.
“What they’ve been doing over the past few months is really trying to take back control of the story because they’ve been given a massive amount of flak for being too slow to raise rates and too slow to take the strength of the economy,” said Ian Shepherdson, chief economist at Pantheon Economics. “But if they keep banging with… [0.75 percentage point rate rises] in the fall, I’d be really concerned that that would be overdone.”
Wednesday’s decision marks the next phase of the Fed’s campaign to “advance” monetary tightening and get interest rates “quickly” to levels that no longer stimulate growth, having already broken precedent and much further. has gone beyond the quarter-point adjustments typical of past walking cycles.
At one point, after the release of alarming new inflation data earlier this month, market participants began to bet that the central bank would raise interest rates by a full percentage point. But those odds plummeted days later when Fed officials expressed their preference for another 0.75 percentage point correction before the meeting.
The central bank’s decision to raise interest rates aggressively in quick succession stemmed from what it saw as an urgent need to cool the economy and keep expectations of future inflation in check.
Despite inflation reaching new heights, the red-hot housing market has already cooled dramatically, business activity across the country has slowed and several high-profile companies have suspended hiring plans or announced layoffs.
Many economists are now predicting a recession in the next six to 12 months, with labor market momentum declining rapidly and eventually leading to job losses, pushing the unemployment rate closer to 5 percent by some estimates. It now stands at 3.6 percent.
Notably, no policymaker has yet signed an economic contraction, but many officials — including Fed Chair Jay Powell — have admitted that the road to achieving a so-called “soft landing” has narrowed significantly.
“The risks around the economic outlook are becoming more two-sided in my view, but the Fed’s policy rhetoric is still quite one-sided in terms of its focus on inflation,” said Brian Sack, DE Shaw group’s director of global economics. and a former senior Fed official.
“The Fed’s aggressive policy message and aggressive rate changes so far have been productive, but I anticipate the need to move to a more balanced policy message and a slower pace of tightening later this year,” he added.
After this month’s meeting, the Fed will then meet for a policy meeting in September, where they are expected to either raise interest rates by another 0.75 percentage point or switch back to a half-point adjustment. By the end of the year, the fed funds rate is expected to exceed at least 3.5 percent.
How fast the Fed gets there depends on the data. Prices of oil and other commodities have fallen from recent highs, which will help alleviate some of the upward pressure on headline inflation figures. But rises in rents and other service-related costs threaten to offset this, increasing pressure on the central bank not to ease its tightening program.
“They have taken full responsibility for inflation, and yet the inflation they are trying to reduce with monetary policy tools has causes that are not monetary in nature,” said Dennis Lockhart, former president of the Atlanta Fed. “If you’re in that situation, you might be tempted to try even harder.”
Lockhart warns that there is now a greater risk of the Fed going “too long” and doing “too much”.
With a recession now “probable” and consumers likely to start to feel the squeeze of higher borrowing costs, the Fed’s job will become much more challenging, according to Diane Swonk, chief economist at KPMG.
“It’s one thing to feel the pain of inflation,” she said. “But then you add that inflation will fall, but not in a way that doesn’t distort it. [people’s] life while unemployment rises. Then it gets really difficult.”