- The Federal Reserve is widely expected to keep interest rates stable at its meeting next week. Therefore, all eyes will be on what Fed officials say about their future actions.
- With inflation on a downward trend, the Fed has reason to cut rates next year and could do so as early as March, according to market forecasts.
- Fed officials are likely to emphasize the possibility of future rate hikes if inflation does not fall to an annual rate of 2%.
- Fed Chairman Jerome Powell and other Fed officials have tried to convey to the public their determination to bring inflation down to target no matter what.
- The Fed has raised interest rates 11 times since March 2022, driving up borrowing costs for all types of business and consumer loans.
When Federal Reserve officials meet next week, they will almost certainly leave the central bank's key interest rate unchanged – but despite the lack of action, what policymakers say or don't say could still move markets.
Market participants are hungry for information on when the central bank will start cutting its key interest rate, which is currently at its highest level since 2001. The Fed has raised interest rates 11 times since March 2022, driving up borrowing costs for all types of business and consumer loans. The increases are an attempt to slow the economy and curb inflation, which rose to its highest level in 40 years in the summer of 2022.
In recent months, news on inflation has been consistently positive, with consumer price increases falling steadily toward the Fed's target of a 2% annual rate. That has led traders to speculate that the Fed will stop putting so much pressure on the economy and may soon cut interest rates. On Friday, markets expected a 45% chance that the Fed would cut interest rates at its March meeting.
Last month, Fed Chairman Jerome Powell tried to dismiss that idea, saying it was “premature” to speculate about rate cuts and noting that the Fed could raise interest rates if inflation worsens
Several economists predicted that Powell and other Fed officials would continue to push that message in the Federal Open Market Committee's official statement and subsequent press conference, as well as in FOMC members' economic forecasts scheduled to be released Wednesday afternoon.
“Despite the more encouraging news on inflation, we expect Fed officials at their meeting next week to vigorously reject the market narrative that rate cuts could come as early as March,” wrote Michael Pearce, chief U.S. economist at Oxford Economics in a commentary.
At the same time, Fed officials have increasingly acknowledged that their anti-inflation rate hikes have put severe pressure on the economy and risk slowing it too much and triggering a recession. The labor market has slowed in recent months (although not to the point of mass layoffs); Banks have become more selective about who they lend money to; and some sectors of the economy, including the real estate market, have slowed sharply.
The Fed's own “Beige Book,” a collection of anecdotes from business and government leaders across the country, released last month, was full of reports of households struggling to make ends meet and things like that Sharing houses and meals to make ends meet. These effects could worsen the longer interest rates remain high.
Still, Fed watchers generally expect a barrage of tough words from Powell. That's partly because Fed communications are themselves a weapon in the Fed's anti-inflation arsenal. The conventional wisdom among central bankers is that public perceptions of future inflation trends are, at least in part, a self-fulfilling prophecy.
If people believe that inflation will be high in the future, they might behave accordingly and make purchases sooner rather than later to get ahead of expected price increases. It will also encourage them to demand higher wages – both measures that could boost inflation, the theory goes.
And if financial market participants believe the Fed is about to cut interest rates – which usually helps businesses – stock prices could rise and interest rates fall, making it easier to raise money and undermining the Fed's fight against inflation. Given all of these considerations, Fed officials have good reason to be wary of prematurely declaring victory.
The Fed's reputation could also play a role in decisions about when to cut rates and what to say about that possibility. The Fed was criticized in 2022 for being slow to respond to early signs of rising inflation, James Knightley and other economists at ING noted. Powell and other officials may be willing to wait longer to cut rates just to avoid looking foolish again if inflation rises again.
“Playing it safe should appeal to his instinct as a conservative lawyer: Why risk a hard-won reputation when doing nothing will do?” Knightley wrote.
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