Fed is set to leave interest rates unchanged while facing speculation about eventual rate cuts

WASHINGTON– With inflation approaching the Federal Reserve’s 2% target, policymakers are facing (and in some cases nursing) hopes of making a decisive shift in policy and cutting interest rates next year, possibly as soon as spring.

Such a move would reduce borrowing costs across the economy, making mortgages, auto loans and business loans less expensive. Stock prices could also rise, although they have already risen on expectations of cuts, which could limit any further gains.

However, Federal Reserve Chairman Jerome Powell has recently downplayed the idea that rate cuts are coming. With the central bank set to keep its key short-term rate unchanged when it meets this week, Powell has yet to signal that the Fed has conclusively ended its hikes. Speaking recently at Spelman College in Atlanta, the Federal Reserve chairman warned that “it would be premature to conclude with confidence” that the Fed has raised its benchmark rate enough to completely defeat inflation.

But the Federal Reserve’s two-day meeting ending Wednesday will mark the third straight time its officials will keep its key rate unchanged, lending weight to the widespread assumption that rate hikes are over.

After all, the economy is headed in the direction the Federal Reserve wants: On Tuesday, when the government releases its November inflation report, it is expected to show that annual consumer price increases slowed to 3.1 percent, according to a survey of economists conducted by FactSet. sharply from a high of 9.1% in June 2022.

And job openings have declined, meaning companies are less desperate to hire and feel less pressure to dramatically increase wages, which can accelerate inflation. Consumers continue to spend, albeit more modestly, and the economy continues to expand.

These trends suggest progress toward what economists call a “soft landing,” in which inflation reaches the Federal Reserve’s 2% target without causing a recession. Analysts are increasingly encouraged by what they say is an unusually smooth adjustment to reduce inflation.

That more optimistic perspective represents a change in mentality. Last year, many economists had insisted that defeating inflation would require a sharp recession and high unemployment. In fact, the drop in inflation, without an accompanying recession or job losses, is “historically unprecedented,” Goldman Sachs economists wrote in a recent note.

Austan Goolsbee, president of the Federal Reserve Bank of Chicago, said in an interview with The Associated Press last month that the United States is on track to record the fastest annual decline in inflation in history this year. If so, Goolsbee said, the result could be “a soft landing greater than conventional wisdom believes has ever been possible.”

That said, a soft landing is not a sure thing. If, for example, the Federal Reserve miscalculated and kept interest rates too high for too long, it could eventually derail the economy and send it into a recession.

“There is more risk of a recession than a reacceleration of inflation at these interest rates,” said Julia Coronado, president of MarcoPolicy Perspectives, an economic research firm. “So ultimately the next step is likely to be a cut because of that.”

The timing of any rate cut will depend on the health of the economy. A recession – or the threat of one – would likely trigger more and earlier interest rate cuts by the Federal Reserve.

However, Friday’s jobs report for November showed that companies are still adding jobs at a healthy pace, and the unemployment rate fell to a low of 3.7% from 3.9%. These figures suggest that the most anticipated recession in decades is not imminent. Investors have since pushed back their expectations for the Fed’s first rate cut from March to May.

The Federal Reserve could cut rates this year even if the economy chugs along, as long as inflation continues to fall. A continued slowdown in price increases would have the effect of raising inflation-adjusted interest rates, thus making borrowing costs higher than the Federal Reserve intends. Cutting rates, in this scenario, would simply prevent inflation-adjusted borrowing costs from rising.

However, economists say any rate cuts in response to lower inflation may take longer than Wall Street expects because the Federal Reserve will want to make sure inflation is under control before taking such action.

Jim Bullard, former president of the Federal Reserve Bank of St. Louis and now dean of Purdue University’s business school, said that while he believes the Federal Reserve is on track for a soft landing, policymakers They should be cautious about rate cuts.

“I don’t think you want to get too far ahead of yourself on that, because if you start the process of cutting the policy rate and then inflation goes back up, I think that could cause a lot of problems,” Bullard said. These premature cuts have been blamed for the Federal Reserve’s failure to quell inflation in the 1970s.

And if job growth and economic growth remain healthy, then rate cuts may not be necessary in the near term, Bullard added.

“Why lower the policy rate if the real economy is doing well?” she asked. “You might as well sit back and enjoy the deflation.”

Either way, when the Federal Reserve releases its quarterly economic projections on Wednesday, they will include a forecast of where its policymakers believe its key rate will be at the end of 2024. Coronado expects only two rate cuts will be scheduled: half of the cuts of rates the markets expect now.

If the Federal Reserve cuts rates twice in 2024, the first might not happen until the fall. Nancy Vanden Houten, chief U.S. economist at Oxford Economics, says her firm doesn’t expect the first rate cut until the third quarter of the year.

“The Fed will want to see a little more progress before contemplating rate cuts,” he said. “In our opinion, the financial markets have come a long way. “We think the rate hikes are over, but it will be many months before the Federal Reserve starts cutting rates.”