As Federal Reserve officials close in on the end of their tightening campaign, the debate is shifting from how high interest rates need to go to how long they should stay elevated.
Inflation pressures are easing, which could give policymakers room to keep interest rates at or near current levels for the time being. Still, price gains remain well above the central bank’s 2% target, making policymakers hesitant to declare victory.
Introducing the discussion over how long officials may keep rates steady even if inflation continues to decelerate could help them push back on expectations for rate cuts and allow them to keep putting downward pressure on the economy.
“This is the policy dimension that they will likely focus on the most going forward: Not how much higher to take the federal funds rate, but how long to keep it at these levels,” said Brian Sack, a former senior Fed official who earlier this year left D.E. Shaw & Co. after about a decade as head of the investment firm’s global economics group. “There’s still a lot of scope to tighten financial conditions in that way, if they wanted to.”
Fed officials unanimously raised their benchmark rate last month to a target range of 5.25% to 5.5%, the highest level in 22 years. Minutes from that gathering — set for release on Wednesday afternoon — could provide more insight into whether most policymakers believe those increases have already worked their way through the economy or if they still expect to see more effects.
Data Improving
Recent data suggest inflation is moving in the direction policymakers favor. The core consumer price index, which excludes often-volatile food and energy costs, rose 0.2% in July for a second month, marking the smallest back-to-back gains in more than two years. Consumers’ year-ahead inflation expectations also unexpectedly declined in early August, matching a more than two-year low.
Policymakers are not unified on what their immediate steps should be, with some such as Philadelphia Fed President Patrick Harker saying officials can hold rates where they are “for a while” and others, including Fed Governor Michelle Bowman, saying more increases will be needed.
Some officials are downplaying the significance of another potential rate increase, saying the more important takeaway is that they plan to hold rates at restrictive levels.
“I think we’re pretty close to what a peak rate would be,” New York Fed President John Williams told the New York Times this month. “And the question will really be — once we have a good understanding of that — how long will we need to keep policy in a restrictive stance.”
Goldman Sachs Group Inc. economists including Jan Hatzius and David Mericle anticipate the Fed will start lowering interest rates by the end of June, they wrote in a note dated Aug. 13.
A Bloomberg survey of 45 economists conducted July 13-18 showed participants are split on when the first cut will occur. More than one-quarter see a reduction in January 2024, while the median of the group sees the first cut at the following meeting in March, with rates falling to 4.75% by June 2024.
Officials haven’t clarified yet how long they plan to keep rates stable, in part because they haven’t figured it out themselves, said Tim Duy, chief US economist for SGH Macro Advisors. It’s a question some policymakers could tackle when they gather at the Kansas City Fed’s annual Jackson Hole symposium this month.
“The conversation we’re seeing among presidents now, among Fed speakers, is going to be reflective of what’s going to be likely the sideline chatter of Jackson Hole,” said Duy. “We’re transitioning into the next part of this story.”
Median economic projections released in June showed that most Fed officials expected rates to go up by at least another quarter point, on top of the rate increase approved in July. The forecasts also show policymakers anticipate cutting rates to 4.6% by the end of 2024, according to their median projection, but it’s not clear when those cuts would begin.
Investors are largely expecting the Fed to hold rates steady when they gather on Sept. 19-20 and see about a one-in-three chance for a quarter-point hike in November, according to pricing in futures markets.
Officials are reluctant to limit their options until the inflation data show price pressures are decidedly easing. Reports reflecting stable job gains and robust economic growth have led to lower recession odds, but also threaten to reaccelerate price growth.
“I don’t think Powell is ready to completely close the door on that last increase,” said Ellen Meade, an economics professor at Duke University and former senior Fed staff member.
Still, officials are starting to informally discuss how long they’ll hold rates elevated so they can start debating the trade-offs they’ll need to consider. Once the committee agrees that they are done hiking, Powell will work with officials on the language that will eventually make its way into the policy statement, she said.
“They need to have those conversations today so that when they get to tomorrow, they’re ready,” said Meade. “They’re always anticipating what might be the next thing on their agenda.”
--With assistance from Reade Pickert.