Update 787 — Fed Plots One Cut in ‘24;
May CPI Shows Immaculate Disinflation
The Fed today predictably held interest rates steady as it has since July of last year and adjusted its interest rate outlook over the rest of 2024, projecting one cut at an unspecified meeting later this year instead of the previously forecasted three. The Fed’s decision and new expectations came after the May CPI report released this morning, which showed that overall prices did not rise at all on a monthly basis in May.
As the Fed commits more firmly to its higher-for-longer strategy to address inflation, lower-income Americans and their families continue to bear the burden, particularly when it comes to the housing market and first-time mortgage costs. The Fed’s monetary policy also leaves the economy susceptible to the lagging and often unpredictable risks posed by a longer-term high-rate environment. As numerous new voices in Congress highlighted this week, it is about time for the Fed to cut rates. We cover these developments below.
Best,
Dana
Fed Holds Interest Rate Steady, Projects One Cut in ‘24
The Federal Reserve opted to hold the interest rate steady at the 5.25 to 5.5 percent range at the conclusion of its latest Federal Open Market Committee (FOMC) meeting this afternoon. The interest rate decision was widely expected, but all eyes were on the Committee’s rate projections, which indicated that officials expect to cut rates once before the year ends. The last projection, in March, pointed to a consensus call for three cuts this year.
The Federal Reserve has held the target federal funds rate at this 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. Committee officials have now opted to hold rates steady for seven consecutive meetings.
At alternating FOMC meetings, each Committee official indicates with a dot the midpoint of the target range they expect interest rates to reach in the current year, two following years, and in the longer run. At this week’s meeting, Committee officials projected that, if the economy continues to move as expected, interest rates would be cut by 25 basis points in 2024, bringing rates to the 5.25 to 5.5 percent range at the end of this year.
In its last two such projections, issued in March and last December respectively, officials had penciled in three cuts in 2024. But earlier this year, and until the May CPI reading was released this morning, inflation had been slower to decline than previously expected while the labor market remained remarkably strong, pushing officials to alter their projections and opt for a higher-for-longer approach.
FOMC Participants’ Assessments of Appropriate Monetary Policy: Midpoint of Target Range or Target Level for the Federal Funds Rate (June 12, 2024)
Source: Federal Reserve, Summary of Economic Projections, June 12, 2024
Additionally, the Committee projected that they would cut rates four times in 2025 bringing interest rates to 4.1 percent at the end of 2025 and four times during the next year to 3.1 percent by the end of 2026.
In his press conference following the meeting today, Fed Chair Jerome Powell said that the Fed is prepared to respond if the labor market weakens unexpectedly or if inflation begins to fall more quickly than expected.
Headline Inflation Flat in May; Main Drivers
In a good sign for the FOMC as it began its second day of deliberation this morning, the Bureau of Labor Statistics released its latest Consumer Price Index data, which showed that headline inflation remained unchanged in May, rising by 0.0 percent, after rising by 0.3 percent in April and by 0.4 percent in March and February respectively. Headline CPI over the past twelve months showed prices rising 3.3 percent, down slightly from the 3.4 percent in April and 3.5 percent in March.
Core CPI, which excludes food and energy prices, rose by 0.2 percent over the month after rising by 0.3 percent in April and by 0.4 percent in each of the first three months of this year. Over the prior twelve months, core CPI rose by 3.4 percent, falling to its lowest annualized level in roughly three years.
This morning’s CPI data shows that headline inflation remains in the three to four percent range and that core inflation continues to come down steadily.
Source: Council of Economic Advisers
Energy prices fell by 2.0 percent in May, after rising 1.1 percent in April, as gasoline prices fell by 3.6 percent over the month. Meanwhile, food prices rose by 0.1 percent on a month-on-month basis in May after being unchanged in April.
The price of shelter was a major contributor to the monthly increase in core CPI. The shelter index increased 0.4 percent in May. Prices of both rent and owners’ equivalent rent (OER) – calculated by estimating the monthly rent that homeowners would theoretically pay if they paid monthly rent on their homes – rose by 0.4 percent over the month. The Fed has been paying particular attention to housing costs – or shelter costs, as it is referred to when discussing inflation – which play an outsized role in how inflation is measured.
Inflation has fallen significantly from its peak in June of 2022 but this progress is not yet enough for the Fed. Powell indicated that officials were still seeking greater confidence that inflation, as measured by the Fed’s preferred inflation gauge, the personal consumption expenditures price index, is moving sustainably toward the Fed’s target of two percent before it begins cutting rates. He stressed that he believes inflation is still too high to begin cutting rates.
The Fed Should Cut Rates Sooner Rather Than Later
Although the Fed has yet to see inflation at its two percent target over the prior twelve-month period, cutting rates sooner rather than later could avoid risks that a higher-interest-rate environment brings to the financial sector. Ahead of this week’s meeting, Senators Elizabeth Warren (D-MA), Jacky Rosen (D-NV), and John Hickenlooper (D-CO) highlighted exactly this concern in a letter to Powell. In a separate letter, House Budget Committee Ranking Member Brendan Boyle (D-PA) and Senate Budget Committee Chair Sheldon Whitehouse (D-RI) also highlighted such risks and said that the FOMC should begin cutting rates at their June 2024 meeting.
As numerous members of Congress, led by Sen. Warren, have highlighted over the past year, housing costs have remained a key contributor to overall inflation. As Boyle and Whitehouse discuss, high interest rates have exacerbated the housing supply crisis by driving up the cost of developing new housing. Higher interest rates have also pushed mortgage rates up. The average rate on a 30-year fixed mortgage briefly exceeded eight percent, reaching a 20-year high, in October, and surpassed seven percent in February. Higher mortgage rates have pushed potential first-time homebuyers to wait for a lower-rate environment and put pressure on the rental market.
Additionally, the Fed’s spate of interest rate hikes is having a lagged effect and will continue to ripple across the economy for months to come. Lags in its full impact that may be hard to see through economic data. The continuing impact of elevated rates may expose risks that may be difficult to predict and successfully respond to, like the risk of some banks failing to effectively manage losses in their portfolios due to higher interest rates.
Over the coming weeks, the Fed will have to weigh the extent to which its monetary policy is having the opposite-than-desired effect, along with 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 their target outcomes. The FOMC will meet next on July 30 and 31.