Here’s the good news.
After its most aggressive interest rate hikes in 40 years, the Federal Reserve on Wednesday is expected to approve a final quarter-point increase and signal a long-awaited pause, economists say.
The prospect of rate increases ending should be welcome relief for consumers and businesses struggling with higher borrowing costs. And it could ease the worries of investors battered by the market-dampening fallout from the 13-month rate hiking campaign. Any sign of a halt would come sooner than anticipated, and underscore that the recent failures of Silicon Valley Bank and Signature Bank have acted as a kind of rate increase by curbing lending, economic growth and, most critically, inflation.
Now, the not-so-good news.
The Fed has no plans to unfurl a “Mission Accomplished” banner. It’s expected to say it’s prepared to raise interest rates further if inflation and the labor market don’t cool down as projected. And the central bank will likely stress it doesn’t plan to cut interest rates this year, as markets are forecasting, even in the event of a widely predicted recession. Fed officials don’t expect rate cuts until 2024.
“They’re not afraid of having a shallow recession,” says Barclays economist Jonathan Millar. “They want to avoid causing a deep recession.”
Will the Fed raise rates again this year?
In other words, the Fed will probably signal that while it’s pausing, it’s poised to raise or lower rates this year but is more likely to lift them, Millar says.
Economists expect the Fed to remove guidance in its March post-meeting statement that “some additional (rate increases) may be appropriate” to lower inflation to the Fed’s 2% target. Instead, Goldman Sachs expects the central bank to say current rates are likely enough to achieve that goal but the Fed will closely monitor economic data to determine its next interest rate moves.
Such a strategy wouldn’t come as a surprise. In March, the Fed forecast that it would raise its key rate by another quarter point to a range of 5% to 5.25% and then halt the inflation-fighting effort, which has hoisted the benchmark rate from near zero in early 2022.
Recent economic data offer a mixed picture of inflation. A government report last week revealed that the Fed’s preferred gauge of inflation fell to 4.2% last month from a 40-year high of 7% last June. But an underlying “core” measure that strips out volatile food and energy items remained higher than estimated at 4.6%.
Also, a barometer of wage growth showed that U.S. employees’ pay and benefits increased 1.2% in the first quarter, topping the fourth quarter pace and economists’ estimates. Companies often pass along higher labor costs to consumers through higher prices.
What could cause the Fed to raise interest rates again?
“We think a June hike is back on the table if inflation progress stalls along with continued strong employment gains in May,” Barclays wrote in a research note.
The Fed expects core annual inflation to fall to 3.6% by the end of the year, according to its March forecast. That would require monthly price increases to average less than 0.3%, Barclays says. If data in the next few weeks shows inflation exceeding that pace, “that might be grounds for another hike,” the research firm says.
Similarly, monthly job growth has slowed from 472,000 in January to 236,000 in March. If May payroll gains top 200,000, that also could lead the Fed to bump up rates in coming months, Barclays says.
Morgan Stanley, however, also notes that such developments “would have to be weighed against information on bank lending and its economic effects.” Put simply, if the banking crisis is restraining borrowing and the economy by more than expected, the Fed would have to balance the conflicting forces.
“It’s a tricky proposition,” Millar says.
Why would the Fed lower interest rates?
Barclays says rate cuts this year “are very unlikely, unless a broad-based financial crisis or a very significant external shock hits the economy.”
Barclays expects a recession that begins in the second half of the year to cause about 800,000 job losses and push the unemployment rate from its current 3.5% to 4.9% by early 2024.
That’s a milder-than-average downturn, Millar says, adding it would take a more severe slump to prod the Fed to trim rates this year.
“We think that a moderate recession will unfold (later this year) but the Fed will not be able to respond by cutting rates since inflation will remain elevated and sticky,” says Kathy Bostjancic, chief economist of Nationwide Mutual.
