WASHINGTON (AP) — Inflation is declining and parts of the economy appear to be weakening. But Chairman Jerome Powell was likely to stress Wednesday that the Fed’s main focus remains on fighting soaring prices with high interest rates.
As financial markets expect the Fed to halt rate hikes soon and possibly even cut rates later this year, analysts say Powell will need to bounce back on such optimism. . The central bank’s already dangerous job could become even more difficult if financial markets expect interest rates to be lower than the Fed’s plans.
Powell’s stark message will be made clear at a press conference after the Fed’s 19-member policy committee announced its latest actions. Policy makers plan to raise the benchmark interest rate by a quarter of a percentage point to a range of 4.5% to 4.75%, the highest level in about 15 years. The move could further raise borrowing rates for businesses as well as consumers, from mortgages to auto loans to business loans.
In some ways, the Fed’s challenge is trickier than last year, when inflation accelerated much faster than officials expected. After being caught off-guard, Powell initially characterized high inflation as only a temporary phenomenon, but officials gave a clear view of what was needed. A series of aggressive rate hikes to slow borrowing and spending, cool growth and keep high inflation in check.
But now, inflation has weakened since the fall. As a result, there is a growing risk that the Fed’s rate hikes will plunge the economy into a painful recession, leading to a wave of unemployment. Consumer prices have risen only 2.9% annually over the past three months, according to the Federal Reserve’s recommended index. Still, Fed officials say they need to see more evidence that inflation is approaching its 2% target before considering a moratorium on rate hikes.
Firms have delivered healthy wage increases over the past year in an attempt to attract and retain enough workers, but Powell warned that strong wage growth in labor-intensive service sectors would push inflation too high. By charging higher prices, businesses typically pass on increased labor costs to customers, thereby perpetuating inflationary pressures.
Some economists don’t think the Fed needs to raise interest rates significantly, and that doing so would increase the risk of a deep recession. Morgan Stanley economists have suggested Wednesday’s rate hike will be the last rate hike of the year as inflation continues to ease over the next few months.
The Fed could signal an imminent moratorium on rate hikes by changing the wording of the statement it issues after each policy meeting.
“It would be appropriate to continue to raise the[interest rate]target range” from March onward, the statement said. Some economists hope officials will slightly change that part of the statement to make it less specific and give the Fed more flexibility.
Still, Powell is unlikely to signal a moratorium on rate hikes any time soon, and worries that such a message could lead to a rally in stocks and bonds. These trends can boost the economy and inflation by allowing consumers to spend more money and encouraging people and businesses to borrow more. This is the exact opposite of what the Fed wants.
“Everything he says has to be hawkish,” said Vincent Reinhardt, chief economist at Dreyfuss & Mellon & Co. and a former Fed executive. (In Fed terminology, “hawks” usually favor higher interest rates to control inflation, while “doves” often lean towards lower interest rates to support employment.)
“Basically everyone is saying, ‘Chairman Powell, let’s play the winning lap,'” Reinhart said. “And he said, ‘We’re only where we are because we’re vigilant, and we can’t let it down now.'”
Financial markets are bullish in anticipation of future interest rate declines. In December, Fed officials predicted he would raise the key rate above 5%. However, investors expect interest rates to remain in the 4.75% to 5% range, with interest rates likely to be cut later in the year. That’s true, despite Chairman Powell’s insistence that the Fed has no plans to cut rates this year.
The gap between the Fed and financial markets is important because rate hikes need to affect the economy through the market. The Fed directly manages major short-term interest rates. But it only indirectly controls the borrowing rates that people and businesses actually pay, such as mortgages, corporate bonds, and auto loans.
The results can be seen at home. After the Fed first started raising rates, the average fixed rate on 30-year mortgages soared. It ended up being over 7%, more than double what he had before the start of the hike.
Since the fall, however, the average mortgage rate has fallen to 6.13%, the lowest level since September. Home sales fell further in December, but the number of signed contracts for home purchases actually rose. This suggests that lower interest rates may lure some homebuyers back into the market.
Broader measures of so-called “financial conditions,” including corporate borrowing costs, also point to declining credit quality.
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