If something is clear to the governor of the Federal Reserve (Fed), Jerome Powell, is that he must keep the focus fixed on recovering price stability and not sell the skin of the bear before hunting it. It is the priority. Up to 113 times he mentioned the word inflation during his 45-minute appearance on Wednesday before journalists and analysts to explain why he has decided to reactivate interest increases in July (to 5.25-5.5%) after adopting a pause in June. It will now reopen an eight-week hiatus until its next decision – in August there is no meeting – after taking rates to their highest level since 2001.
Powell left the door open to raising rates again in September if they deem it appropriate and the economic situation requires it, but recalled that the Fed has adopted a ‘data-dependent’ approach. “We will go meeting by meeting. As we enter each meeting, we ask ourselves the same question. We have not made any decisions on future meetings, including the pace at which we consider raising interest rates.”
The banker recalled that during the remaining two months until then, a good number of indicators will be known that will shape the decision to raise rates or maintain them. “We suspect that evidence of slower inflation and weaker activity will not make it necessary. By the September 20 FOMC meeting, we will have had two additional reports on employment and inflation, a detailed update on the state of bank lending and more time to feel the lagged effects of the Fed’s tightening measures already in place,” said James Knightley, chief international economist at ING.
From his point of view, Knightley sees possible that in September headline inflation will be a little higher than energy costs but believes that core inflation will slow further to around 4%. The problem will be another and it seems that it will have more weight in another probable pause of the Fed. “The manufacturing industry is clearly struggling, but the labor market remains tight and the services sector continues to expand. Over the next two months, we believe headwinds for activity will intensify, as banks’ outstanding commercial loan volume will decline further due to the combination of higher borrowing costs, which Powell described as ‘restrictive’, and stricter lending standards.
When will rates fall in the US?
Lowering them is not yet a short-term option, but Powell elaborated for the first time in a long time on what needs to happen for that to happen. He didn’t cut off his answer, but naturally crafted a scenario. “There are people who anticipate rate cuts in 2024. It’s because they have a sense that inflation is declining and we’re comfortable with that decline, which indicates that it’s time to start cutting rates. But I want to say there’s a lot of uncertainty about what’s going to happen in the next cycle of meetings, let alone the next year or the year after,” he explained. When will that happen?
In Powell’s view, two factors to consider are the speed and proximity of the 2% target level, as well as credible disinflation. “We would be comfortable reducing rates when we are sure to do so. I don’t think that will happen this year. That will be a decision we will have to make in a full year’s time. It will depend on how confident we are that inflation is actually falling towards our 2% target,” he said.
In this sense, the Fed chairman cut that the current level of rates is already in a restrictive terrain for the financing of households and companies. “If we see inflation falling credibly and sustainably, we no longer need to be at a restrictive level. We can go back to a neutral level and then below a neutral level at a certain point. I think, of course, we would be very careful about that. (…) It’s hard to make a miraculous new assessment of when and where that would be, but here’s how I see it: we would stop raising rates long before we hit 2% inflation, and start cutting them before we get to 2% as well,” he said.
An aggressive rate cycle without recession or unemployment
The appearance oozed optimism on the part of the head of the Fed, who ruled out that the US economy will enter into recession in 2023 and reinforced the thesis of the ‘soft landing’. Powell was satisfied because he is close to completing the task of controlling inflation but without hisA cumulative rate of 550 basis points – the most aggressive since the Volcker and Reagan recessions of the ’80s – has caused the economic and job destruction that many, himself, feared. What seems like good news also hides a small print that the Fed’s command risk radar identifies as a potential threat.
“It is a very positive thing that the unemployment rate is the same as we had in March 2022, when we started implementing measures, at 3.6%. It is a blessing that we have achieved some disinflation. We haven’t sought to raise unemployment, not that we’ve aimed for that, but let’s be honest with the historical record, which suggests that when central banks intervene to slow the economy and reduce inflation, the result tends to be weakening labor market conditions. Therefore, it is still likely to happen here,” Powell warned in his speech. On the increase in consumer confidence in recent months or stronger growth than expected, the Fed is clear that all this can push up inflation and force it to respond with more interest rate hikes.
