Update 776 — Fed High-Wire Act Extended

Update 776 — Fed High-Wire Act Extended:
Powell’s Pause with No Clear End in Sight

The Fed has decided to hold its elevated interest rates constant yet again. The good news is that the Fed is implicitly confident that the economy can still withstand the higher rates for longer. The bad news is the recent data showing prices higher than the Fed would like and growth coming in lower than expected in the last quarter. Until things change, the more rates will stay the same.

Chair Jerome Powell is clear that Fed policy is made free of political considerations. Nonetheless, the Fed’s coming decisions will have a bearing on voters’ views on the economy as we approach November, with the ripple effects of the Fed’s decisions already made continuing to impact all consumers. See below.



Fed Holds Rates Steady Once Again

How many times will the Fed cut interest rates in 2024 — three times as per its last formal projection, or fewer… or not at all? This question overshadowed the Federal Open Market Committee’s (FOMC) highly-anticipated decision to hold interest rates steady for the sixth consecutive time.

In his press conference following the FOMC’s meeting today, Federal Reserve Chair Jerome Powell gave no indication of whether Committee officials still saw potential for three cuts to interest rates this year but hinted strongly that the Fed may hold rates higher for still longer. He said, “…we do not expect that it will be appropriate to reduce the target range for the federal funds rate until we have gained greater confidence that inflation is moving sustainably toward two percent. So far this year, the data has not given us that greater confidence.” He continued, “It is likely that gaining such greater confidence will take longer than previously expected.” Powell outlined two paths that may lead the Fed to cut rates: one in which inflation begins to come down or another in which inflation continues to move sideways, while the labor market weakens. 

The Federal Reserve has held the target federal funds rate at the 5.25 to 5.5 percent range, a 23-year high, since last July after hiking rates from near zero in early 2022 in its most aggressive series of interest rate hikes since the early 1980s. 

Since its series of rate hikes began, the Fed’s preferred measure of inflation – the personal consumption expenditures (PCE) price index – has fallen significantly from its peak of 7.1 percent in June 2022. PCE had been approaching the Fed’s target of two percent for months, falling to 2.5 percent in January, remaining flat the next month. The labor market has also remained quite strong over this period — unemployment stayed below four percent while growth surged in the latter half of 2023, with a soft landing in sight. As recently as March, the Committee projected three rate cuts of 25 basis points each this year, with Powell stating that rates were likely at their peak. But he said the Committee needed additional confidence that prices were still headed toward the Fed’s goal before initiating cuts, specifying no timetable. 

Data released last Friday showed that headline PCE ticked up to 2.7 percent in March. This data surely reinforced Powell’s view that inflation remains too high. Powell is now saying that the Fed is willing to hold rates at an elevated level for a more extended period even if inflation stabilizes above the two percent target. Today’s pause gives FOMC officials more time to consider incoming economic data before moving to cut, perhaps at the risk of the soft landing that seemed within reach at the start of the year.

Fed to Consider Lag, Neutral Rate, Consumer Spending

At this stage in the Fed’s ongoing cycle and maintenance of rate hikes, FOMC officials are aware that its monetary policy increasingly runs the risk of a contractionary effect on the economy. Fed Governors have noted that this “long and variable” lag is currently thought to last anywhere from 9 to 24 months but can be difficult to predict. 

The Fed had held interest rates near zero for over a decade after the 2008 financial crisis. During this period, many households and businesses locked in low interest rates on borrowing. Additionally, between 2020 and 2022, mortgage rates fell below 3.0 percent and more than 14 million homeowners refinanced. These factors may have insulated some households from some potential impacts of the Fed’s hikes. The adjustment has been especially jarring for many younger and lower-income households not similarly insulated.

The risk of an economic downturn poses a challenge for the central bank. The American economy’s remarkable resilience in the face of the Fed’s cycle of rate hikes — with real GDP growing by a strong 2.5 percent last year — is showing signs of fatigue. Growth over the first quarter of this year came in lower than expected at 1.6 percent, significantly below the real GDP increase of 3.4 percent in the final quarter of 2023. According to the Bureau of Economic Analysis, this deceleration in growth between the fourth quarter of 2023 and the first quarter of 2024 partially reflected a “deceleration in consumer spending,” which has driven the post-pandemic recovery of the U.S. economy. The data showed that consumer spending, while still strong, grew less in the first quarter of 2024 than during the last quarter of 2023. 

The disappointing growth in the first quarter of 2024 shows that weakness in consumer spending is becoming more pronounced. Many households have burnt through savings and financial relief garnered during the pandemic. According to the Federal Reserve Bank of New York’s Household Debt and Credit report for the first quarter of 2024, credit card debt has risen by over 20 percent since the pandemic, reaching $1.13 trillion late last year, while delinquencies have begun to rise. Although the ratio of credit card debt to income remains below the pre-pandemic level, the report shows that the rate of delinquencies is rising particularly among younger and lower-income households. The Fed must be wary of the burden its interest rate hikes place on younger and lower-income consumers who are just starting their lives or struggling financially. 

The Fed must also consider whether the neutral rate — the rate of interest that would have neither a restrictive nor stimulative impact on the economy, or on inflation and the labor market — has risen above the pre-pandemic level of two percent in recent years. If it has, the Fed’s steep interest rate hikes may not be as restrictive as the Fed intends, and may not have the intended impact on inflation. 

As the Fed holds rates higher for longer the impact of its monetary policy decisions will continue to ripple across the economy, affecting the financial decisions of all market participants as borrowing remains more expensive. 

Hikes’ Impact on Consumer Confidence Ahead of Election

The Fed has consistently been clear that its monetary policy decisions are independent of partisan politics and election cycles. Today Powell reaffirmed that political considerations are “just not part of our thinking.”

The Fed’s decisions will nonetheless influence voters’ outlook on the economy as we approach the 2024 congressional and presidential elections. Inflation has continued to be a major talking point for Republicans on the campaign trail, even as data has clearly shown that inflation has fallen dramatically. Democrats, including Senators Elizabeth Warren (D-MA) and Sherrod Brown (D-OH), urged Powell to reverse the Fed’s recent interest rate hikes earlier this year, citing concerns that high interest rates have made housing even less affordable and accessible to American families and that interest rate hikes have stalled growth of small businesses.

While Democrats have made their concerns clear in letters and questions to Powell at congressional hearings, Democrats have consistently respected the independence of the Fed. The same respect for independence cannot be guaranteed for Donald Trump and his allies. In February, Trump baselessly accused Powell of considering rate hikes geared to help Democrats in the coming election, even as Powell has ignored calls by Congressional Democrats to lower rates over the past year. Just last week, the Wall Street Journal reported on plans drafted by Trump allies that would reduce the Fed’s independence. While in office, Trump said that he had the right to fire Powell and tweeted “…who is our bigger enemy, Jay Powel (sic) or Chairman Xi?”

All Eyes Projections of Cuts at FOMC’s June Meeting

In the coming months, the Fed will have to weigh the risks of holding interest rates at an elevated level for too long against those of loosening monetary policy before the economic data reflects progress toward its inflation target. Over that period, FOMC members will consider two sets of data outlining inflation during April and one set of data describing inflation in May (the May CPI report to be released on the second day of the Fed’s next meeting). 

The FOMC will meet next on June 11 and 12, after which attention will no doubt be on new economic projections in which officials lay out whether they continue to see cuts later this year and if so, how many and of what magnitude. The Fed must consider the many uncertainties we discuss today — the long and unpredictable nature of lags, the possibility that the neutral rate has risen, and the burden of its monetary policy decisions on those already struggling — as it makes its coming decisions.