By Howard Schneider
WASHINGTON (Reuters) – Federal Reserve officials are in “uncharted territory” and lack clear historical guidance as they set monetary policy in an environment of falling inflation but no rise in the unemployment rate yet, Richmond Fed officials said in a new one Research Note They analyzed a central bank interest rate cycle that they felt was “unlike any other.”
“The current cycle marks the first time in the entire post-war period that the (Federal Open Market Committee) has made significant progress in reducing inflation without resulting in a rise in the unemployment rate,” wrote Richmond Fed officials, including the senior adviser Pierre-Daniel Sarte, in the newspaper Papier, published Wednesday on the bank’s website.
“The current interest rate episode takes us into uncharted territory” as when officials began tightening monetary policy in March 2022, the Fed faced the largest gap between inflation and the Federal Reserve’s target interest rate and now found that the unemployment rate remained stable and low despite the fastest rate hike in at least 40 years, the researchers wrote.
Whether this free drop in inflation can continue will be the focus of the Fed’s discussion in the coming weeks as policymakers decide whether they have hiked rates enough or whether more rate hikes are needed.
New data due to be released Thursday morning could do little to stimulate the discussion.
Economists polled by Reuters expect the CPI to have risen at an annual rate of 3.3% in July, up slightly from June’s 3% reading.
However, that headline is influenced by the fact that some of the largest monthly price increases recorded in mid-2022 are now falling out of the current annual calculation.
Underlying price trends are expected to show a continued slowdown in inflation, with the annualized consumer price index excluding food and energy costs rising 3.2% in July compared to 4.1% in June, Omair wrote Sharif, President of Inflation Insights.
The story goes on
“The summer of disinflation is likely to continue,” despite the rise in headline inflation, he said.
The Fed’s direction so far is good: CPI inflation has fallen from a peak of 9.1% in June last year.
The Fed has raised the federal funds rate by 5.25 percentage points since March of last year, with policymakers approving rate hikes at 11 of the last 12 meetings. This is a set of measures designed to discourage borrowing and spending, slowing both the economy and the pace of price increases.
Typically, this would be associated with a rise in unemployment as businesses and consumers decline. Still, the unemployment rate has been below 4% since February 2022 – the lowest for the US – and was 3.5% last month.
Federal Reserve policymakers have interpreted the reasons for this in different ways, from “labour hoarding” at companies battered by recruitment difficulties during the pandemic, to inflation that may largely be due to problems in supply chains is that have slowly corrected themselves. Others believe the economy will remain slow to adjust to higher interest rates and that the unemployment rate will eventually rise before the Fed ends its fight against inflation.
How Fed officials analyze these kinds of nuances will determine whether they go ahead with another rate hike sometime this year — the majority view among policymakers, according to their latest projections in June — or whether they decide to maintain the current target rate range between 5.25% and 5.5% is sufficient.
Their next meeting is on September 19-20, and many analysts and investors are betting at this point that the Fed will not hike rates again.
Policymakers were reluctant to commit. The gap between the last Fed meeting in July and the next is an unusually long eight weeks, so two full months of data need to be considered.
In June, a closely watched price index, the non-food and energy personal consumption expenditure index, was still more than double the Fed’s 2% target. So far, only two Fed officials have publicly stated that they think rates don’t need to be raised, while others said they want the “entirety” of available data before making a decision.
Given the unique circumstances, the Richmond Fed researchers identified risks on both sides.
They wrote that the current Fed has so far been “uniquely successful in bringing down inflation while keeping the unemployment rate at its lowest level in about half a century,” with the possibility that monetary tightening to date “resulted in further declines in the… could lead to inflation without it being the case.” Dramatic increase in the unemployment rate. This would be a first in the post-war US economic experience.
Still, “the FOMC must remain vigilant not to miss its target should the economy prove more resilient than expected, given little guidance from past interest rate cycles.”
(Reporting by Howard Schneider; Editing by Andrea Ricci)
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