The Federal Reserve is poised to take another dramatic step this week to rein in alarming inflation, but the US central bank’s strategy beyond that point is less certain as it hangs another spike in price growth. consumption with increasing risks of recession.
The Federal Open Market Committee is expected to confirm market expectations on Wednesday and raise its benchmark policy rate by 0.75 percentage points for the second month in a row. This will take the federal funds rate to a new target range of 2.25% to 2.50%, in line with the long-term estimates of those responsible for a “neutral” policy framework.
A series of interest rate hikes are expected beyond July, but with emerging signs of consumer distress emerging and tentative expectations that the worst of recent inflationary shocks has passed, the Fed now faces an increasingly difficult task to decide how to recalibrate its trajectory.
“What they’ve been doing over the past few months is really trying to take back control of the narrative because they’ve taken a massive amount of flak for being too slow to start raising rates and too slow to recognize the strength of the economy,” said Ian Shepherdson, chief economist at Pantheon Economics. “But if they continue to bump with [0.75 percentage point rate rises] in the fall, I would be really afraid that it would be exaggerated.
Wednesday’s decision marks the next phase of the Fed’s campaign to “accelerate” its monetary tightening and “rapidly” bring interest rates down to a level that no longer stimulates growth, having already shattered the precedent and exceeded the quarter-point adjustments typical of past trail riding cycles.
At some point after the release of alarming new inflation data earlier this month, market participants increased bets that the central bank would raise rates by even a full percentage point. However, those ratings fell a few days later as Fed officials signaled their preference for another 0.75 percentage point adjustment for the meeting.
The central bank’s decision to raise rates aggressively in quick succession stemmed from what it saw as an urgent need to cool the economy and ensure future inflation expectations remained in check.
Although inflation has hit new highs, the scorching housing market has already cooled considerably, business activity across the country has slowed and several prominent companies have suspended hiring plans or announced layoffs. .
Many economists are now forecasting a recession in the next six to 12 months, with a rapid slowdown in the labor market and possible job losses that will push the unemployment rate closer to 5%, according to some estimates. It is currently at 3.6%.
Notably, no policymaker has yet forecast an economic contraction, but many officials — including Fed Chairman Jay Powell — have admitted that the path to a so-called “soft landing” has drastically shifted. narrowed.
“Risks around the economic outlook are becoming increasingly 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, director of global economics for the DE Shaw group. and a former senior Fed official.
“The Fed’s hawkish policy message and aggressive rate changes to date have been productive, but I foresee the need to shift to a more balanced policy message and a slower pace of tightening later this year,” he said. he added.
After this month’s meeting, the Fed will then reconvene for a policy meeting in September, where it is expected to either raise rates an additional 0.75 percentage points or move to a half-point adjustment. point. By the end of the year, the federal funds rate should at least exceed 3.5%.
How quickly the Fed gets there will depend on the data. Oil and other commodity prices have fallen from recent highs, which will help ease some of the upward pressure on headline inflation numbers. But rising rents and other utility costs threaten to offset that, increasing pressure on the central bank not to ease its tightening program.
“They’ve taken full responsibility for inflation, and yet the inflation they’re trying to bring down with monetary policy tools has causes that aren’t monetary in nature,” former chairman Dennis Lockhart said. of the Atlanta Fed. “When you’re in this situation, you might be tempted to try harder.”
Lockhart warns that there is now a greater risk that the Fed will go on “too long” and do “too much”.
With a recession now “likely” and consumers likely starting to feel the pinch of higher borrowing costs, according to Diane Swonk, chief economist at KPMG, the Fed’s job is set to get much tougher.
“It’s one thing to feel the pain of inflation,” she said. “But then you further add that inflation is going to come down, but not in a way that doesn’t distort [people’s] lives, even as unemployment rises. This is where it gets really difficult.