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The Federal Reserve spent most of last year in emergency mode struggling to catch up with inflation. Now central bankers agree that phase of their work is coming to an end. They’re still trying to figure out what’s next.
Fed officials will convene for their first policy meeting of the year on Jan. 31 and Feb. 1, when they will raise interest rates for the eighth consecutive month to combat pandemic-era inflation. Exactly how much is not yet certain. Financial markets and analysts are increasingly expecting a quarter-point rise – up from half a point in December – partly on the back of encouraging data showing inflation is falling further. Smaller rate hikes from now on would also give the Fed more flexibility, economists say, as the central bank figures out how much higher rates are needed. Officials still believe interest rates need to rise a little, despite signs that inflation has peaked.
But zoomed out, the Fed’s next moves will reveal a deeper diagnosis of where the economy stands. A slower pace, Fed watchers say, would make it clear that the central bank is no longer in a desperate game of catch-up. Instead, it may now be more alert to the risks of exaggeration, especially as policymakers have yet to see how drastically what they did last year could affect the economy in 2023.
In a speech Thursday, Fed Vice Chair Lael Brainard said the full impact of the steps the Fed has already taken are “likely” yet to come. Brainard has also outlined a number of reasons why inflation could trend further down: Wage growth appears to be moderating, supply chains are improving, rents on new leases are slowing and inflation expectations are still well anchored.
The goal is for the economy to keep moving in this direction without interest rates getting so high that companies will scale back investment and hiring, and the labor market suffers as a result. The Fed has a two-part mandate: control prices and encourage “maximum employment”. Care must be taken not to lean too much to one side and risk injuring the other.
“The further we move into restrictive territory, the more two-sided the risks surrounding our dual mandate become,” Brainard said in a comment on Thursday. “Now we’re in an environment where we’re managing risk on both sides.”
Outside of emergencies, the Fed prefers to move slowly, turning rates up or down by a quarter of a percentage point. Kaleb Nygaard, an expert on Fed history and host of The Reserve podcast, noted that the Fed has hiked rates 47 times since the central bank began announcing changes to the federal funds rate in 1994. Thirty-six was in quarter-point increments.
“They don’t know what the peak price should be,” said Derek Tang, an economist at research firm LH Meyer/Monetary Policy Analytics. “You feel like you’ve caught up, but you don’t know where the end point is. So approach the matter more cautiously. There they grope their way.”
It makes sense to proceed step by step. Aside from interest rates, the Fed’s decisions cut through all types of lending to businesses and consumers. Last year, for example, his aggressive moves triggered a huge spike in mortgage costs and wrecked a white-hot real estate market.
But then again, last year wasn’t the norm. The Fed spent 2022 trying to get inflation back under control as prices skyrocketed over the summer, rising 9.1 percent from a year earlier — a higher mark than at any time since 1981. As officials struggled to to keep up, they did it, abandoning more traditional quarter-point hikes and handing out two half-point hikes and four three-quarter-point hikes by the end of the year.
You are not done yet. According to the Fed’s latest economic forecasts from mid-December, officials expect a rate hike above 5 percent, which could mean three more hikes (of 0.25 percentage points each) or two (with hikes of 0.50 and 0.25 percentage points). . Then they will pause and keep prices high.
In general, officials agree that the central bank is nearing its peak. But they disagree on how to get there. The path they choose will be shaped by a jumble of up-to-date data. The latest inflation report showed that prices fell for the sixth straight month in December. China is also reopening, which could soon boost consumer and business activity and help stave off a global slowdown.
Still, retail sales and wholesale prices fell more than expected, stoking recession fears on Wall Street. Job cuts aren’t widespread, but layoffs in industries like tech, finance, and housing are still piling up. On Wednesday, Microsoft announced it would cut 10,000 employees to cushion a downturn.
Also, when officials gather for their first day of meetings, the Bureau of Labor Statistics will release a new report on the Employment Cost Index, a closely watched metric that looks at labor prices.
That means the Fed needs to make another call about where the economy is going based on what it now knows. Officials have been publicly voicing their positions in recent days as the central bank prepares to enter a two-week “blackout period” ahead of its next meeting, during which policymakers will stop making remarks that would tip the bank or could affect the financial markets.
Boston Fed President Susan Collins told the New York Times that she is tending to slow the pace. And Philadelphia Fed President Patrick Harker backed a few more hikes of 0.25 percentage points.
“We’re starting to see things working,” Harker said in a note at the University of Delaware last week. “We are getting closer to where we need to be. So I think it’s wise at this point not to just rush up the hill and then possibly have to go straight back down. Let that sink in.”
In a Wednesday speech, Lorie Logan, who heads the Dallas Fed, also outlined reasons why easing might make sense. She said that just as the Fed pared hikes by three quarters of a point in favor of half a point in December, “the same reasoning points to slowing the pace further at the upcoming meeting.”
Others, however, warn against retiring too soon. St. Louis Fed Chairman Jim Bullard said another half a percentage point hike would be appropriate, telling an event with the Wall Street Journal that the Fed “should act as soon as possible.”
Loretta Mester, Cleveland Fed President: “I think we just have to move forward,” she told the Associated Press, “and we’ll discuss at the meeting how much needs to be done.”
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