Federal Reserve policymakers on Wednesday decided to forego any move in their policy rate, leaving the target at 5% to 5.25% to allow time to assess the impact of previous monetary tightening. But they are still feeling their way in the dark to identify the rate level that will bring down high and stubborn inflation, and the Fed’s Summary of Economic Projections (SEP) suggests they are not there yet. The SEP’s mean projection for fed funds rates rose even higher than projected inflation, meaning the committee sees the need for higher real rates to exert sufficient restraint on the economy. A year ago, the Fed thought it could tame inflation by holding policy rates about 1.1 percentage points above projected inflation, but rate-panel members have begun to reconsider that.
Now, the typical policymaker thinks “real rates” will need to exceed inflation by 2 percentage points in 2024. The implication is that even if deflation picks up later in the year, rates could remain quite high.
The phrase “sufficiently restrictive,” is, of course, one of the intentionally vague entries in the Fedspeak dictionary that is hard to define with any precision. You can try to quantify it (as I have done above), but it is constantly changing with the shifting profile of the US economy. For his part, Fed Chair Jerome Powell was circumspect about the level of rates that would be “substantially restrictive” at his press conference on Wednesday. asked about it by a cnbc journalist, he objected to specifics: “What we want to see is credible evidence that inflation is going up and then starting to come down. That’s what we want to see. Of course that’s what we want to see, and I think it’s also… [And] We understand that there are gaps. But remember that it’s been over a year since the financial situation started to tighten. I think the reason we’re staying comfortable [the rate-hike cycle] It’s that there was a lot of tightening last summer and later in the year, and I think it’s reasonable to think that some of that may be coming into effect.”
Adding to the confusion is the notion that policymakers revised their implicit estimates of “restrictive enough” at the same time they unanimously halted interest rate hikes. wall street journalK’s Nick Timiraos asked Powell, “If you know you have more work to do, why not extend it now?” In his response, Powell said the pace and the right level of tightening were somewhat different questions: “The pace was very important last year. As we get closer and closer to the destination, and according to the SEP we are not far from the destination according to most people, it is reasonable, common sense to slow down a bit.”
It is also true that the Fed itself seemed to be shutting down. In the weeks following the last policy meeting, several officials strongly indicated an intention to ‘skip’ a meeting in June. The US central bank is generally reluctant to surprise markets, so once the words of ‘quit’ are priced in, the panel may find it difficult to follow.
While Powell was able to brush aside any formal dissent at last Wednesday’s Fed committee meeting, the SEP suggests that some policymakers are clearly becoming uncomfortable with the way that inflation is reacting — or failing to react. Fail – 500 basis points rate hike since March 2022. The top ‘dot’ in the SEP – which also includes an anonymous ‘dot plot’ of individual committee members’ forecasts – showed a risk of rates moving from 6% to 6.25%. Broadly speaking, the Fed’s preferred inflation measure—the US core personal consumption expenditure deflator—has shown an essentially steady rate of price increases over the past year. By that measure, inflation isn’t accelerating, but it isn’t coming down either.
Meanwhile, there are some signs that the rate-sensitive housing market may be starting to recover slightly, and the job market remains quite resilient.
There will always be some who believe that policy-makers are bluffing to buy themselves some time. And while I’m not necessarily one of them, I’ll allow some room for that possibility.
Clearly, there is a risk that further loosening of financial conditions could work against the Fed’s goals of fighting inflation, and some officials may have used their ‘aggressive’ projections to guard against this. Is. While key core inflation indices remain extremely high, there are clearly some optimistic developments under the hood, and it may take time for them to work their way up.
In any case, Fed policymakers are indicating that they think the level of “sufficiently restrictive” policy rates is realistically higher — than previously thought. And if the past year has taught the markets anything, it’s that it pays to listen more closely.
Jonathan Levin has worked as a Bloomberg reporter in Latin America and the US, covering finance, markets and M&A.
©Bloomberg
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Updated: June 18, 2023, 11:27 PM IST