Jay Powell reveals the Fed’s hand on US interest rates

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Weeks before their last meeting in 2023, Fed officials appeared to have one goal in mind: maintain as much flexibility on monetary policy as possible to end what has become an uphill battle to tame inflation.

On Wednesday, President Jay Powell changed course.

Between the new tone in the policy statement, new expectations pointing to a less aggressive path for interest rates, and Powell’s comment during a press conference, the signals pointed in one consistently pessimistic direction.

The shift overshadowed the US central bank’s other, more expected announcement on Wednesday, which was that it would again hold interest rates at current levels for a third straight meeting.

Instead, not only has the Fed signaled that its multi-year campaign to tighten monetary policy is now coming to an end, but officials have also begun to consider sharper cuts to borrowing costs next year – a move aimed at achieving a soft landing for the largest economy. In the world.

Together, this has brought cheer to Wall Street, with stocks rising and government bond yields falling. By Wednesday evening, the yield on 10-year Treasury bonds had fallen below 4 percent for the first time since August.

Traders in the federal funds futures markets have increased their bets that the central bank could start cutting its benchmark interest rate as early as March, and that interest rates could end next year below 4 percent, well below their current level of 5.25 percent to 5.5 percent. Highest level in 22 years.

But at a time when the inflation outlook remains highly uncertain, economists said this is exactly the kind of enthusiastic outcome the Fed needs to avoid, or risk making its task of fully taming price pressures more difficult.

The fear is that looser financial conditions leading to a cheaper cost of capital could unleash another wave of borrowing and spending by businesses and households, undoing some of the central bank’s efforts to curb demand and cool the economy.

“It could be down to the last mile [of getting inflation down to target] “It’s going to be more difficult, because they won’t have as tough financial conditions as they need to,” said Vincent Reinhart, who worked at the Fed for more than 20 years and now works at Dreyfus & Mellon.

“Investors are like kids in the back seat saying, ‘Are we there yet?’ And they will keep saying [that] At every meeting and their prices will make the trip longer.”

The main risk facing the Fed is if the economy — and the strong jobs market — continues to defy expectations of a slowdown, which in turn prevents inflation from falling as quickly as officials now expect, said Dean Mackey, chief economist at Point72 Asset Management.

“It’s not clear that the labor market right now is in line with the Fed’s 2 percent target,” he said, referring to the central bank’s inflation target. “I think there is a risk to the strategy at this point without seeing more inflation or labor market data.”

While monthly job growth has slowed recently, demand for workers in industries ranging from leisure and hospitality to health care remains strong. Mackey said these sectors could maintain a rapid pace of employment and consumer spending.

Powell hinted at those risks on Wednesday, saying it was still “too early” to declare victory over inflation and that further progress “cannot be guaranteed.”

But while he reiterated that the central bank could raise interest rates again if necessary, Powell’s warning rang hollow.

One reason for this was the change in the Fed’s statement, which indicated the conditions under which it might consider any further tightening.

“We added the word ‘any’ as an acknowledgment that we are likely at or near the peak rate of this cycle,” Powell said.

This view was supported by forecasts released on Wednesday that showed that most central bank officials do not believe interest rates will rise further and that they expect more cuts next year than shown in a “dot chart” preceding their forecasts issued in September.

They now expect the interest rate to fall by 0.75 percentage points in 2024 and another full percentage point in 2025, before stabilizing between 2.75 percent and 3 percent in 2026.

Powell did not clarify what criteria the Fed would use to decide when to start cutting, but he indicated that officials would take into account low inflation, to ensure that interest rates do not remain too high for households and businesses.

He added that the central bank is “strongly focused” on not waiting too long to cut interest rates.

Wednesday’s turnaround was made possible by officials’ more moderate inflation forecasts, as well as expectations of slower growth and marginally higher unemployment next year. Powell also said the effects of higher interest rates since March 2022 have not yet been fully felt across the economy.

This helped explain why the Fed was less concerned about looser financial conditions, said Michael De Passe, head of linear interest rates trading at Citadel Securities.

“They seem to be comfortable with the pace of lower inflation, they are comfortable with the fact that they think the current level of interest rates is fairly restrained, and they are comfortable with the fact that there is still some tightening in the pipeline that has increased inflation.” “He didn’t get his way,” he said.