U.S. central bankers (Fed) are likely to maintain their inflation fight in high gear this week, even as they escalate a debate over when to downshift to smaller interest rate hikes to prevent pushing the world’s largest economy into a tailspin.
With the Fed’s preferred gauge of inflation running at higher than three times its 2% goal, the outcome of the central bank’s policy meeting on Tuesday and Wednesday is not known: it will jack up rates by three-quarters of a percentage point for the fourth consecutive time, bringing the target overnight lending rate to a 3.75%-4.00% range.
But what follows is less clear.
After the previous meeting, last month, Fed Chair Jerome Powell said that “at some point” it will be convenient to reduce the pace of rate hikes and assess how the steepest rises in borrowing costs in four decades are affecting the economy.
Defining that point, or at least its parameters, will be the topic of heated discussion at this week’s Federal Open Market Committee meeting. Or is the bar simply that inflation needs to stop intensifying, even if it takes time to actually improve?
How will a slowdown in China, an impending recession in Europe, and rising global commodity prices fueled by the conflict in Ukraine affect the U.S. outlook for inflation?
How to make up for the lagging effect of increasing U.S. rates, which are slowing the housing market significantly but have yet to bite into the wider economy or boost the unemployment rate, currently at 3.5%?
Projections published at the end of the Sept. 20-21 meeting imply that most of the Fed’s 19 policymakers expect to be able to start slowing rate hikes in December and achieve a peak policy rate of 4.50%-4.75% next year.
But economic data since that meeting has been differing, with U.S. inflation still scorching hot but some signs that household spending and job growth are reducing.
During that time, Fed policymakers, with the particular exception of Powell, have given a range of views on where they stand on a potential slowdown or even a stop to rate hikes.
Fed Governor Michelle Bowman, for example, said she’ll search for signs that inflation is going down before she would want to slow the pace of rate hikes. Minneapolis Fed President Neel Kashkari flagged he would be comfortable if inflation just stopped surging.
It is not clear that two days of discussion are enough to settle those differences. Nomura economists wrote on Friday:
“There does not yet appear to be a consensus on the Committee about the preferred size of a December hike, limiting Powell’s ability to offer guidance.”
The Fed chief will instead, those economists and others forecast, draw attention to the range of data still to come before any decision needs to be taken – including two more monthly reports on the state of the U.S. job market and, above all, new inflation readings.
Barclays’ economists also wrote on Friday:
“There is little reason for the committee to limit its optionality for December, as even the most dovish participants would likely prefer more information about how inflation and overtightening risks are evolving before signaling a policy turn.”
‘Need To Be Convinced’
Bets in futures markets support a slowdown in rate hikes beginning December, but ultimately a top Fed policy rate of 4.75%-5.00%, slightly higher than policymakers themselves have indicated, by early 2023.
“Everything is squared up to do 50 (basis points) in December,” said Vincent Reinhart, chief economist at Dreyfus-Mellon, and then to hike rates a bit further to a plateau that’s high enough to put inflation on a downward trend.
Other global central banks are flagging slower tightening onwards, with the Bank of Canada moving to a half-percentage-point rise last week and a slightly less aggressive tone from the European Central Bank as it reported its own 75-basis-point rate hike last week.
Fed policymakers, Reinhart said, also fully realize that monetary policy normally goes too far. He said:
“You tighten too much, you ease too much, you wait too long because you need to be convinced. And knowing that … they’ll slow the pace.”
But, anything from Powell that suggests he views the Fed’s September projections as stale could reverse expectations for a December downshift and facilitate a more hawkish touch.
