The Federal Reserve under Chair Jerome Powell might never live down its misguided insistence on “transitory” inflation, and its delayed decision to raise interest rates to slay the beast. Now, some Fed watchers think the central bank is making another policy mistake by waiting too long to start cutting rates, thereby risking a hard landing for the U.S. economy.
High interest rates tighten financial conditions and exacerbate the housing market’s affordability crisis. They also stifle clean-energy investments and stress household balance sheets, says Rakeen Mabud, chief economist at the Groundwork Collaborative, a progressive economic advocacy group. “It’s pretty clear to me that the Fed needs to cut rates immediately,” Mabud says, and she isn’t alone.
Yet, the evidence so far suggests the Fed is right to exercise patience and delay rate cuts. Based on recent jobs reports, the labor market remains robust, with no need for lower rates to stimulate employment. As for price stability—the other half of the Fed’s so-called dual mandate—inflation has cooled markedly in the past 18 months, but not enough to suggest that price growth is sustainably on the path back to a 2% annual rate. That leaves most Fed officials, including Powell, wary of jumping the gun and easing monetary conditions.
The Fed chair all but ruled out a rate cut in March, barring some kind of economic shock, in comments at a press conference following the January Federal Open Market Committee meeting. He then doubled down on the message in a Feb. 4 interview with 60 Minutes, saying the committee wants to be more confident that inflation is moving down to 2% before starting rate cuts. “It’s not likely that this committee will reach that level of confidence in time for the March meeting,” Powell said.
Other Fed officials have warned that easing monetary policy prematurely could reignite inflation, or stall progress in taming price growth. “Patience is warranted,” Thomas Barkin, president of the Federal Reserve Bank of Richmond, told Barron’s in a Feb. 7 interview, adding that he wants to see a deceleration of inflation in rents and services, where price growth has been sticky.
The next day, in a speech to the Economic Club of New York, he cited the ongoing impact of pandemic-related changes to the economy as a further reason to delay rate cuts. Disruptive shocks can have “lasting consequences,” Barkin, a voting member of the FOMC, told the crowd, noting that “robust demand and a historically strong labor market” give the Fed time to build confidence that inflation won’t re-emerge.
Financial markets have been eager for the Fed to lower interest rates almost since it began hiking them in March 2022. Enthusiasm for rate cuts swelled in December, after Powell essentially signaled the hiking regime was over.
Many economists and analysts called out the fact ahead of the January FOMC meeting that the Fed’s preferred inflation gauge had been running at an annualized rate of 1.9% over the past seven months, presumably an indication that the central bank would soon begin to ease. At the time, markets priced in more than 65% odds of a rate cut in March, according to the CME FedWatch Tool.
Based on trading in federal funds futures, those odds had fallen to 17.5% as of Jan. 9.
Prominent political voices have also contributed to the rate-cut chorus. Sen. Elizabeth Warren (D-Mass.) repeatedly urged the Fed to ease monetary policy over the past eight months, arguing that higher interest rates are detrimental to home affordability and suppress new housing construction. Ahead of January’s Fed policy meeting, she co-authored a letter to Powell calling for the central bank to reverse its restrictive monetary policy.
“The Fed’s sky-high interest rates are driving up costs for working families and putting affordable housing out of reach for too many Americans. It’s time for the Fed to cut interest rates to lower costs,” Sen. Warren said in an email to Barron’s on Wednesday.
Based on history, the current federal funds target rate of 5.25%-5.50% could be viewed as “sky-high” only by comparison with the near-zero rates that prevailed for much of the period following the 2008-09 financial crisis. Before that, rates were often in the 5% area, although they hit a high of 19% in the 1980s when the Fed battled soaring inflation.
“Of course there’s a concern about a policy mistake given that even by Chair Powell’s view, the Fed started hiking a bit late,” says Brett House, an economics professor at Columbia Business School. “So there is concern they may be cutting late, as well.
That concern, however, isn’t consistent with recent data on the U.S. economy, he says, citing the still-strong labor market and doubts about whether the Fed’s price-stability mandate has been fully achieved. While consumer inflation is around 3% today, down from 9% at its peak in 2022, much of the progress reflects falling goods prices. Pricing pressures remain in the larger services sector, as Barkin noted.
Fed officials can afford to be patient because economic activity is still strong and unemployment is near historic lows. While many lower-income and younger Americans are feeling the bite of higher interest rates, U.S. consumers in the aggregate continue to spend, says Curtis Dubay, chief economist at the U.S. Chamber of Commerce.
“Consumers may not have the savings or credit-card availability they had six months to a year ago, but price pressures have eased and their wages are still growing faster than inflation, so they’re using that to keep spending up,” Dubay says.
Although Americans’ savings rate is below pre-pandemic levels, that isn’t an indicator that a near-term rate cut is necessary, says Philipp Carlsson-Szlezak, BCG’s global chief economist. “When people feel good about their balance sheets and their employment outlook, they tend to save less,” he says. “Additionally, a high savings rate typically means less consumption—and that’s not great for the overall economy.”
Credit-card balances and delinquencies also aren’t yet approaching troubling levels, even though total household debt is about 36% above the level logged in mid-2008, when high rates of personal debt helped drive the U.S. into a financial crisis. Yet, household income is up 85% since 2008, meaning that Americans are significantly less leveraged today, according to a recent analysis from Wells Fargo Economics.
Despite affordability issues, the housing sector has held up well due to low inventory, Carlsson-Szlezak says. There was some concern that buyers would disappear last fall when mortgage rates soared, but demand has remained strong. If housing hasn’t been a “big negative headwind” by this point, Carlsson-Szlezak says he’d be surprised if that’s the thing that tanks the economy. The “doomsayers” are wrong, he says.
Monetary policy currently is restrictive, and if the Fed keeps it so for too long, the economy could face a hard landing. “The Fed will need to cut at some point in 2024,” House says.
But recently strong economic reports have given the Fed much-need flexibility to await convincing data indicating inflation is on a durable path toward 2%.
Until that evidence arrives, the Fed’s patience is prudent.
Write to Megan Leonhardt at [email protected]
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