The Federal Reserve has been raising interest rates since March to combat inflation. But at some point the Fed will have to slow down and stop raising interest rates. The big question is when.
Whether it’s Federal Reserve Board governors or Wall Street investors, they all live with the same numbers. However, there are different views on what to do with interest.
“If you stop too early, you get more inflation,” said Steve Blitz, chief US economist at TS Lombard. “If they go too long, they create a recession.”
The fact is, we don’t know if what the Fed has already done has already been fully reflected in the economy. Every time the Fed hikes rates, which it did seven times last year, there is a long lag of many months to more than a year before the full effect is felt. Imagine trying to decelerate a car by using both the accelerator and the brake. That’s the case for small rate hikes from now on.
“That gives you time to get feedback from the economy and from the inflation rate on the impact of monetary policy,” said Don Kohn, a senior fellow at the Brookings Institution and former Fed vice chairman.
On the other hand, some central bankers believe rates need to reach at least 5% to wipe out inflation. So speed is less of an issue.
“If you’re confident about where you’re going, there’s no reason to take it slow,” Kohn said.
However, it could appear that the economy is already showing clear signs of slowing down. Retail sales fell in December and wholesale prices even fell.
But economic indicators are like bricks — you need a few in a row to build anything.
“The slowdown in economic activity is a very recent development,” said Matthew Luzzetti, chief US economist at Deutsche Bank. “It’s unclear how persistent that is and how much weight you put on what you think is going to happen with monetary policy.”
It is also unclear how much the labor market will have to suffer before inflation can be brought under control. A tight labor market contributes to services inflation, but how big is that when goods inflation is already falling?
“Because we’re not sure how quickly some of these prices will reverse, we’re not sure how much softness in the labor market we might need to finish the job on inflation,” said Chris Varvares, co- Head of US Economics at S&P Global Market Intelligence.
According to futures markets and the CME FedWatch Tool, markets are expecting the Fed to ease and go down the slow path at its next meeting on February 1st.
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