When will the Fed cut interest rates? While the US economy flexes its muscles, maybe later or not at all

WASHINGTON – Since the Federal Reserve signaled last fall that it was probably done raising interest rates, Wall Street traders, economists, car buyers, would-be homeowners — pretty much everyone — have been grappling with a single question: When will the Fed start cutting rates ?

But now that the US economy is off to a surprisingly strong start, another question arises: Will the central bank actually cut interest rates three times this year, as the Fed itself predicted – or cut them at all? Typically, the Fed only cuts interest rates when the economy appears to be weakening and needs help.

Lower interest rates would reduce borrowing costs for homes, cars and other large purchases and would likely lead to higher stock prices, all of which could help accelerate growth. An even more robust economy could also benefit President Joe Biden's re-election campaign.

Friday's blockbuster jobs report for March reinforced the assumption that the economy is doing just fine on its own. The government said employers added a huge surge in jobs last month – more than 300,000 – and the unemployment rate fell from 3.9% to a low 3.8%.

Some analysts responded by arguing that it was clear that the last thing the economy needed right now was more stimulus from lower interest rates.

“If the data is too strong, why are we underperforming?” asked Torsten Slok, chief economist at Apollo Global Management, an asset management firm. “I think the Fed will not cut interest rates this year. Higher (interest rates) for a longer period of time is the answer.”

In March, central bank policymakers – as a group – had planned three interest rate cuts for 2024, as they did in December. Some economists still expect the Fed to make its first rate cut in June or July. But even at last month's Fed meeting, some cracks had emerged: Nine of the 19 policymakers forecast only two rate cuts or less in 2024.

Since then, Friday's jobs data, combined with a better-than-expected report showing factory output picking up after months of decline, suggest the economy is continuing an unexpected period of healthy growth. Despite the Fed's aggressive series of rate hikes in 2022 and 2023, which caused mortgage rates and other borrowing costs to rise, the economy is defying long-standing expectations of a slowdown.

Such trends have made some Fed officials nervous. Although inflation has fallen sharply since its peak, it remains stubbornly above the Fed's 2 percent target. Rapid economic growth could reignite inflationary pressures and reverse the progress made.

In a series of speeches last week, several Fed officials stressed that there was little reason to cut interest rates any time soon. Instead, they need more information about exactly where the economy is heading.

“It is far too early to be thinking about cutting interest rates,” Lorie Logan, president of the Federal Reserve Bank of Dallas, said in a speech. “I need to ensure that the uncertainty about what economic path we are on is further resolved.”

Raphael Bostic, head of the Atlanta Fed, said he only supports a rate cut this year – and not until the last three months. And Minneapolis Fed President Neel Kashkari sent stocks lower Thursday afternoon after raising the possibility that the Fed might not cut interest rates at all this year.

“If we continue to see strong job growth,” Kashkari said, “if we continue to see strong consumer spending and strong GDP growth, then to me that begs the question: Why should we cut interest rates?”

However, a strong economy and the hiring of new employees do not necessarily preclude wage reductions. Chairman Jerome Powell and other officials such as Cleveland Fed President Loretta Mester have stressed that the main factor in the Fed's rate-cutting decision is when — or if — inflation falls back to the central bank's 2% target. They point out that the economy managed to grow strongly in the second half of 2023 despite steadily falling inflation. According to the Fed's preferred measure, inflation is now just 2.5%, after peaking at 7.1%.

Still, in January and February, “core prices” – which exclude volatile food and energy costs – rose faster than the Fed's target, raising concerns that inflation has not been fully contained.

Therefore, the government's upcoming inflation reports will be examined for signs of further moderation in inflation. The consumer price index report released Wednesday is expected to show that core prices rose 0.3% from February to March, generally too fast for the Fed's liking.

One reason Powell suspects the economy can continue to grow even as inflation cools is that labor supply has risen sharply over the past two years. This trend makes it easier for the economy to produce more and avoid shortages, even as demand remains strong. It also helps keep wage and price growth under control.

The surge in immigration over the past two years, much of it unauthorized, has dramatically increased the number of workers willing to take jobs. Their entry into the labor market has largely ended the labor shortage that plagued the economy after the pandemic and led to a rise in wages for workers in retail, restaurants and hotels.

“There are significantly more people working,” Powell said in a discussion at Stanford University this week. “It’s a bigger economy, not a tighter one.”

Whether this trend of increasing labor supply can continue this year will help determine the Fed's next steps.

Still, even Powell acknowledged at a Fed meeting in San Francisco last month that the healthy economy reduces the urgency to cut rates: “This economy doesn't feel like it's suffering from the current level of interest rates.”

In fact, Slok and some Fed officials believe that borrowing costs are no longer slowing the economy as much as in the past. That's because in today's economy, several trends could result in growth, inflation and interest rates being higher than they have been in the last two decades. These include a more productive economy, larger government budget deficits and the repatriation of some manufacturing goods from overseas to the United States, where they are more expensive.

“It is extremely difficult to argue that the Fed should cut rates at all – and the debate over raising rates again is likely to be more lively than it is now,” said Thomas Simons, an economist at Jeffries, a brokerage firm.