Stubborn inflation may prompt the Fed to keep interest rates high for longer

Investors are abandoning dreams of imminent interest rate cuts as inflation remains stubborn, a problem that could prompt Federal Reserve policymakers to keep borrowing costs high for longer.

The latest reading of the Fed's most closely watched measure of inflation, released on Friday, showed that price increases were still significantly faster than the Fed's 2 percent target.

Personal consumption expenditures index It rose by 2.7 percent in March compared to the previous year, compared to 2.5 percent in February. After excluding volatile food and fuel prices to get a clearer reading of price trends, inflation remained steady at 2.8 percent on an annual basis.

The report was just the latest sign that after months of steady improvement in 2023, progress in cooling inflation will stall in 2024. This unexpected hurdle has policymakers, economists and investors wondering when the Fed might be able to… To what extent he might be able to do so. To reduce borrowing costs. Fed Chairman Jerome Powell indicated last week that central bankers were not seeing the progress they had hoped to see before cutting interest rates.

The Federal Reserve meets next week in Washington to discuss the next move for interest rates. While he is widely expected to leave interest rates unchanged in his May 1 decision, investors will be watching a news conference with Mr. Powell closely for hints about how long interest rates are likely to remain unchanged. If inflation continues to remain flat in the coming months, this could prompt officials to keep interest rates at their current relatively high level for an extended period while they try to rein in the economy and eliminate price increases completely.

“There is a lot more uncertainty about the deflationary path,” said Matthew Luzetti, chief US economist at Deutsche Bank, noting that “we continue to see an economy that is doing very well.”

Policymakers raised interest rates to 5.33% between March 2022 and last summer, and have kept them steady since then. They believe this amount is high enough to eventually impact the economy — which, in economics parlance, is “constrained.”

But some economists are beginning to question how restrictive the Fed's current interest rate setting is, because growth has remained strong and hiring is brisk even after months of relatively high interest rates.

Data released Friday showed that the momentum continued in March: Consumer spending rose 0.8 percent for the second month in a row, beating forecasters' expectations. This spending is being supported by a strong market that is pushing wages higher: Americans' after-tax income in March significantly outpaced price increases for the first time since December.

Separate data for A University of Michigan Survey Data on Friday showed that consumers became slightly more pessimistic in April about the outlook for the economy as a whole and inflation in particular.

Stock indexes rose on Friday morning, in part because Wall Street was bracing for a slightly worse inflation report after data released Thursday suggested price gains may have been hotter in March than personal consumption spending numbers.

Friday's numbers “can be viewed with relief,” Omair Sharif, founder of Inflation Insights, wrote in a note following the report.

However, investors see a greater chance of a prolonged period of higher interest rates — which tend to weigh on stock prices — than they did just a month or even a week ago. Investors are now betting that the Fed may make its first move in September or later. Based on market prices. A small but growing percentage believes the central bank may not be able to cut interest rates at all this year.

Given the economic momentum, some economists wonder whether Fed officials could start thinking about raising interest rates again.

Federal Reserve Governor Michael Bowman He already said it Although this was not her “fundamental expectation,” she saw “the risk that at a future meeting we may need to raise the interest rate further.”

While markets are likely to focus on whether interest rates might rise again, the Fed is likely to keep them high for longer, said Plerina Orochi, chief U.S. economist at T. Rowe Price.

She said it would likely take an outright acceleration in inflation to prompt the Fed to raise borrowing costs again, rather than just the stalled progress seen in recent months.

“I don't think we've reached the point where we need to talk about raising interest rates this year,” Ms. Orochi said. “But we are definitely at the point where we need to talk about lower cuts.”

Many economists believe inflation is still likely to slow further, partly because new, cooler rental prices are still slowly feeding into official inflation data. But the process is taking longer than many expected, and as the economy strengthens, the risks of inflation remaining flat have increased.

In addition, economists have regularly found their inflation expectations upended by economic surprises in recent years: It was not expected to rise as quickly as it did in 2021 and 2022, and then fell a little more quickly than many expected late last year. Now, its flatness was a surprise.

“After the last several years, you have to be humble,” Mr. Luzetti said.

Higher interest rates are intended to curb inflation by making consumers and businesses more reluctant to spend. To some extent, this appears to have happened: High mortgage interest rates have led to a sharp slowdown in the housing market, companies have withdrawn capital investments and fewer jobs have been created.

But the economy as a whole has proven remarkably resilient to the effects of rising borrowing costs. Consumers were not particularly deterred, choosing to withdraw savings and run up credit card debt even as they complained about rising prices. Americans saved just 3.2% of their after-tax income in March, the lowest rate since 2022.

Portland Gear, a clothing retailer in Portland, Oregon, continues to set records as customers buy $79 T-shirts and $36 baseball caps, said Marcus Harvey, the company's founder.

“Consumers may say things have become more expensive, but their purchasing habits don't really reflect that,” he said.

As a result, Mr. Harvey continues to invest, despite the impact of higher interest rates. The company recently opened a flagship store in downtown Portland and is opening a location at the city's airport.

“This is the case: Over the next five years, interest rates are going to be high,” Harvey said. “You can't do anything about it. Work goes on. Life goes on.”