Since the Federal Reserve started raising interest rates in its battle against inflation 18 months ago, the US central bank has made one thing clear: all policy options must be kept on the table at all times.
From jumbo interest rate rises — it has implemented several — to the repeated warnings that they could remain elevated for an extended period, chair Jay Powell has refused to rule out anything that will enable the Fed to get a grip on price pressures that have proved far more persistent than most economists and policymakers ever expected.
He stuck to that line on Wednesday, after the central bank’s latest decision to hold its benchmark federal funds rate at a 22-year high of between 5.25 per cent and 5.5 per cent, for the second gathering in succession. Powell used a press conference afterwards to stress that additional rate rises would very much remain an option if the economic conditions warranted it.
“The question we’re asking is, should we hike more?” he said.
It was a prompt that lingered over an hour-long media conference, and yet Powell made little effort to suggest the Fed was readying further tightening. The conclusion of leading economists afterwards was plain: the central bank at this stage is likely done with the rate-rising phase of its historic monetary policy campaign. Its focus from now on is not how high rates should go, but how long they should stay at elevated levels.
“The overall message is that the Fed wants to say ‘we are done’ and the bar has really risen for further tightening,” said Yelena Shulyatyeva, a senior US economist at BNP Paribas.
Underpinning this view was Powell’s repeated emphasis that the central bank would continue proceeding “carefully” with future interest rate decisions, given not only how much it has raised rates since March 2022, but also amid signs that all that monetary tightening is starting to have an effect.
“We’ve come very far with this rate-hiking cycle,” Powell said. “We’re proceeding carefully because we can proceed carefully at this time. Monetary policy is restrictive [and] we see its effects.”
Powell drew that conclusion despite a recent spate of surprisingly strong data that showed the staying power of American consumers and businesses’ unexpectedly robust demand for workers — a demonstration of the economy’s resilience that has prompted concern among economists that the recent fall in inflation could stall or even reverse.
But Powell on Wednesday largely dismissed those fears, emphasising instead that inflation was coming down even if further progress could “come in lumps and be bumpy”. Even the recent acceleration in jobs growth had been driven primarily by increased labour supply, he noted — a welcome, not alarming, development.
The improved backdrop had left the Fed in a much less reactive mood, said analysts.
“Last year, because inflation was so far from target, they didn’t have the luxury of even letting one strong data print go by. They almost had to respond each time,” said Priya Misra, a portfolio manager at JPMorgan Asset Management. “Now, they’re able to buy time because inflation is lower.”
The sharp tightening of financial conditions over the past two months, following a surge in long-term interest rates, has also bolstered the view that the Fed can take a less hawkish stance on rates. The Federal Open Market Committee’s statement on Wednesday said as much, stressing that tighter financial and credit conditions “are likely to weigh on economic activity, hiring, and inflation”.
Powell said monetary policy would depend in large part on the duration of the market moves, which have seen government bond yields hit multiyear highs.
Torsten Slok, chief economist at Apollo Global Management, said the implications of higher borrowing costs should not be underestimated.
“Ultimately, Fed hikes and tighter financial conditions will continue to increase delinquency rates for consumers, increase default rates for companies and put downward pressure on loan growth,” he said.
Slok’s worry is a “sudden stop” in consumer spending and business activity that snowballs into a painful economic contraction. Misra and Shulyatyeva are also bracing themselves for a so-called hard landing next year.
So far, staffers at the Fed are not forecasting a recession. But Powell did acknowledge that the risks of doing too little to tackle inflation versus doing too much had become more “two-sided”.
Even if the Fed appears to be in a more comfortable place in its battle against inflation, economists warn that the coast is not entirely clear. As Powell spoke on Wednesday, equity markets rallied and US government bond yields edged lower, delivering slightly looser financial conditions on the day.
That could prove problematic if the economic data remains strong, warned Richard Clarida, who previously served as the Fed’s vice-chair and is now at bond manager Pimco.
“They need financial conditions to tighten to help them reduce inflation,” he said. “The trade-off is that the more relaxed they seem about relying on financial conditions, the easier they may become.”
Getting inflation all the way back to the Fed’s 2 per cent target is poised to be far more difficult than the initial retreat from last year’s peak in rates, Clarida warned, saying that he would opt for another rate rise in December if he were still at the central bank.
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