Federal Reserve Chair Jerome Powell has been clear that the U.S. central bank is staging a two-part inflation fight. First comes the question of how high to raise interest rates. Then, comes the concern of how long to keep them there.
But much to the chagrin of market participants, Fed officials have been stressing that they’re nowhere near ready to tackle the second debate — even if it looks like they’ve finally finished lifting borrowing costs.
Policymakers on the Federal Open Market Committee (FOMC) are widely expected to leave interest rates alone for the third straight meeting. Powell & Co. have been on pause since July when they approved an 11th rate hike that lifted their key benchmark rate to 5.25-5.5 percent, a level not seen since 2001.
Economic data hasn’t given officials a reason to move since then. Employers have created half as many jobs this year as they did last year, job openings have tumbled to the lowest since March 2021 and inflation now stands just about a percentage point above U.S. central bankers’ 2 percent target.
Still, policymakers are guided by nightmare scenarios born from their experiences in the 1970s and ’80s, when the U.S. central bank reversed course too soon and fueled a resurgence in price pressures.
Here are the three big themes to watch ahead of the Fed’s last meeting of the year — and what they mean for your money.
They’re going to attempt to throw some cold water on the expectations that they’re going to be quick to cut interest rates in 2024. We’re going to hear the familiar refrain that policy will have to remain restrictive for some time.
— Greg McBride, CFA | Bankrate chief financial analyst
1. Will officials ever admit they’re likely done raising interest rates?
Officials don’t have to search very hard for reasons it might pay off to stay mum on whether they’ve actually finished raising interest rates — and whether they’re debating the timing of future rate cuts.
The massive tightening in financial conditions last fall that sent mortgage rates pushing past 8 percent and the 10-year Treasury yield barreling past 5 percent has quickly unfurled. Since peaking on Oct. 19, the 10-year Treasury yield has tumbled 86 basis points, helping send the 30-year fixed-rate mortgage down to 7.23 percent, the lowest since August, Bankrate data shows.
On optimism that the Fed might be able to pull off a soft landing in its quest to cool inflation, the S&P 500 topped a new high for the year on Dec. 1. Investors are pricing in rate cuts as soon as March 2024, according to CME Group’s FedWatch tool.
The danger with loosening financial conditions is that it could fuel inflation or more gains in asset prices if it gets out of control. Housing activity, for example, is rate-sensitive. As mortgage rates quickly retreated, refinance applications in the week that ended on Dec. 1 were the strongest in two months, while applications from a year ago rose for two straight weeks for the first time since late 2021, according to data from Mortgage Bankers Association.
“Markets are not only projecting that the Fed is done raising rates, but they’re projecting that the Fed is going to start cutting rates,” McBride says. “Meanwhile, the Fed isn’t willing to admit that they’re done raising rates yet. If markets can move that much without the Fed saying they’re done raising rates, what happens when they actually do?”
In records of the Fed’s November meeting, Fed officials admitted that they’re likely in a place where they can “proceed carefully” and might be able to keep an eye on data arriving in “coming months” to determine whether they need to do more.
Still, Powell made clear in his last speech before officials went on blackout to prepare for their Dec. 12-13 rate-setting meeting that, if the Fed took rates anywhere from where, it’s most likely to be up — not down.
“It would be premature to conclude with confidence that we have achieved a sufficiently restrictive stance or to speculate on when policy might ease,” Powell said in public remarks at Spelman College in Atlanta. “We are prepared to tighten policy further if it becomes appropriate to do so.”
2. How will the Fed keep markets from getting ahead of itself?
The elephant in the room is that policymakers still have one more rate hike penciled in, according to their Summary of Economic Projections (SEP) which they last updated in September. In their widely scrutinized “dot plot” chart, officials penciled in a 5.5-5.75 percent peak target range for the federal funds rate.
But that extra rate hike might just be part of the game of signaling a tightening bias, says Vincent Reinhart, chief economist and macro strategist at Dreyfus and Mellon and a former secretary and economist for the FOMC.
“If the world is biased against you, you have to lean against that,” he says. “They’ve got to talk a tougher game than they think is the outcome.”
Fed officials are set to close out the year with another update to their rate projections. Reinhart says their projections are bound to shift lower for 2023 since the Fed never followed through with that rate hike. But he also sees policymakers perhaps signaling fewer rate cuts for 2024 to keep markets from getting ahead of themselves.
In their last update from September, policymakers penciled in just 50 basis points worth of cuts for next year.
“That’s the way to protest markets pricing in a quick pivot,” Reinhart says. “The Fed is prepared for the last mile to be hard. That’s why they’ve got to keep the policy rate firm for a while.”
3. What will the Fed look for when determining it’s time to cut interest rates?
Fed officials have noted that they’d be willing to cut rates before inflation officially hits 2 percent.
“We’ll keep policy restrictive until we’re confident that inflation is on a sustainable path down to 2 percent,” Powell told reporters after the Fed’s September meeting.
Important to the rate debate is the “real” cost of money — that is, interest rates minus inflation. The Fed’s benchmark borrowing rate has been higher than the overall rate of inflation since May, signaling that policy is officially in a restrictive stance. The more inflation falls, and the longer rates stay at their current 5.25-5.5 percent level, the more steam monetary policy takes away from the U.S. economy.
“There are two ways to cut rates,” Reinhart says. “The messy way is in response to data activity telling you you need a lower real funds policy rate in a hurry. The other way is the way you’d want to do it every time, which is (to) follow inflation down.” Lower rates are like candy to investors, who always seem to crave them. But the reasons for those calls have changed over time. Back when the Fed first started raising interest rates, market participants were jittery about history repeating itself. They priced in rate cuts by December of 2023, on the notion that Fed officials may spur a deep recession just as they did in the ’80s when Fed Chair Paul Volcker tried to bring the last bout of troubling inflation down.
“Investors are thinking that they’re going to have their cake and eat it too,” McBride says, referring to the reasons why they’re pricing in rate cuts. “The hope about a soft landing is appropriate and rightfully placed. But investors have gotten ahead of themselves. To get the number of rate cuts markets are expecting absent a recession means inflation falling down a lot faster than the Fed is expecting it will.”
Emily Roland, investment strategist at John Hancock Investment Management, refers to investors’ optimism about rate cuts as a “pivot party.” The latest figures show the Fed has been successful so far in bringing inflation down without harming the job market or the broader economy.
The Fed’s preferred gauge of inflation hit 3 percent from a year ago in October, while price increases excluding the volatile food and energy dipped to 3.5 percent. At the same time, employers created 199,000 jobs in November, while the unemployment rate slid to 3.7 percent, data from the Department of Labor shows.
But monetary policy acts with a lag, and officials can still discover they’ve slowed the economy too much when it’s already too late, she says.
“There’s a lot of optimism that the Fed can nail the soft landing, but the way we think about it is, Fed policy doesn’t work that way,” Roland says. “You have to wait and see what the impact of the Fed raising interest rates in the shortest amount of time that we’ve seen in four decades is.”
Bottom line
Consumers hoping to mitigate the impact of high interest rates on their wallets will want to pay down variable-rate and high-interest credit card debt. Those debts likely won’t get cheaper anytime soon, while credit card rates are hovering at record highs, Bankrate data shows.
Meanwhile, the uncertainty surrounding the economy underscores the importance of saving whatever you can for emergencies. Stashing your cash in a high-yield savings account can help you grow your rainy day fund more quickly — and preserve your purchasing power in the face of elevated inflation. All of Bankrate’s picks for the best savings accounts offer yields that currently eclipse the overall rate of inflation.
If you already have at least six months’ worth of expenses stashed away and are looking to diversify your portfolio with more risk-free investments, now may be the time to lock in a longer-term certificate of deposit (CD). Those offers are unlikely to get any better than they are now, McBride says.
“We’ve seen this movie three or four times, where markets get way out over their skis and Powell has to bring out the tough talk and rein investors in,” McBride says. “The Fed lifted interest rates higher than markets had expected, so they’re probably not going to cut rates as soon as markets expect.”
