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Federal Reserve chair Jay Powell faces a tough balancing act this week to maintain flexibility in the US central bank’s policy plans in the face of intense pressure to reveal when and by how much it intends to cut interest rates next year.
As the Federal Open Market Committee prepares for its final two-day gathering of 2023 on Tuesday, Powell confronts an increasingly mixed economic picture. While the labour market is resilient and consumer spending is solid, there are signs of slower growth and, in turn, lower inflation.
Against this backdrop, the Federal Reserve is set to hold interest rates for their third policy meeting in a row and keep the federal funds rate at a 22-year high of 5.25-5.5 per cent.
But as officials extend a pause in rate increases that has been in place since July, they are not ready to say interest rates have reached a level “sufficiently restrictive” to get inflation down to their 2 per cent target. Nor are they ready to publicly discuss in greater detail the circumstances under which they would lower borrowing costs next year beyond improved price pressures.
The challenge for Powell this week is financial markets are not buying his warnings that additional monetary tightening is still on the table. Investors believe the world’s largest economy is already slowing enough to obviate the need for further rate rises. Moreover, they are convinced that incoming data will force the Fed to cut interest rates sooner than it expects.
This thinking has led financial conditions to loosen in recent weeks, raising concerns that some of the Fed’s work in trying to damp demand is being jeopardised.
“They probably have a sense that they are done, barring unexpected developments, but there are risks and costs to communicating that and so they have to lean against it,” said Ellen Meade, who served as a senior adviser to the Fed’s board of governors until 2021 and is now at Duke University. “It’s a delicate time because financial conditions are very important in this.”
The chair will have the opportunity to once again drive home the Fed’s message at a press conference on Wednesday, when he is expected to reiterate it is “premature” to declare a policy pivot is under way, even as inflation continues to moderate. The central bank is committed only to moving “carefully” with forthcoming decisions, Powell has indicated.
Before he takes the lectern, the Fed will issue a policy statement and set of economic projections that aggregates individual officials’ forecasts for interest rates, growth, unemployment and inflation.
Economists broadly reckon the central bank will keep the statement unchanged, meaning it will still include a line outlining the conditions the Fed would take into account to determine “the extent of additional policy firming that may be appropriate to return inflation to 2 per cent over time”. Removing that could risk sending too direct a signal the Fed is indeed done with the rate-raising phase of its historic monetary tightening campaign, they argue.
In terms of the projections — which in September forecast the federal funds rate peaking at 5.5-5.75 per cent this year before declining by half a percentage point in 2024 — economists will be watching closely to see if officials have pencilled in more cuts.
Maintaining the same magnitude of cuts next year would help clarify that the Fed is not preparing to abruptly reverse course even as the pace of consumer price growth moderates. Some economists said officials could indicate one additional quarter-point cut in 2024 in recognition of a slightly more benign inflation outlook.
Matthew Raskin, a former senior staffer at the Federal Reserve Bank of New York who is now US head of rates research at Deutsche Bank, said signalling anything more than that could complicate things for the Fed.
“Once you go beyond that, it’s difficult to maintain the message that you’re not close to the point where you’re considering cuts or speculating around it,” he said. Deutsche expects the central bank to cut the policy rate by 1.75 percentage points next year, beginning in June. Economists at Morgan Stanley also believe the Fed will start lowering rates then but only by 1 percentage point over the course of 2024.
While the Fed may not be ready to hint at a policy shift, Constance Hunter at MacroPolicy Perspectives said officials would be flexible as they approached the next stage of their battle against inflation. Powell hinted as much in his final public appearance before the December meeting, saying his approach was to “let the data reveal the appropriate path”.
“They’re not going to go from tightening to easing and skip a neutral bias” Hunter said. “What they would like to do is get to [that] stance as quickly as the inflation data will permit, because they know that policy lags haven’t fully played out and that they’re still going to hit the economy.”