Wall Street Journal reporter Nick Timiraos wrote that even though the Federal Reserve is likely to keep interest rates steady this week, officials' worries about sustained inflation might signal they are readying for another hike later this year. Slowed inflation in May in the United States supports a pause in rate hikes this week, but underlying price pressures remain strong. The Fed is set to release its new quarterly economic forecast, which officials may use to emphasize their expectations for a rate hike.
The Federal Reserve will announce its interest rate decision for the June FOMC meeting on Wednesday. Even if the Fed maintains the current interest rates this Wednesday, officials' concerns about persistent inflation may lead them to signal they are prepared to raise rates again this year.
Timiraos noted that while the Federal Reserve is expected to keep interest rates steady at this week's meeting, futures market investors anticipate another rate hike in the following July meeting. With overall inflation slowing in the U.S. in May, this data could persuade them to pause any rate hikes this week, but underlying price pressures continue to be robust.
The U.S. Department of Labor's CPI report on Tuesday showed that the U.S. May CPI rose by 4% year-on-year, decreasing for the 11th consecutive time, marking the smallest year-on-year increase since March 2021, expected at 4.1%, previous value 4.9%. CPI rose 0.1% month-on-month, lower than the expected 0.2%, previous value 0.4%. The core CPI, excluding volatile food and energy, also slowed year-on-year, rising by 5.3%, lower than the previous value of 5.5%, marking the lowest since November 2021, but slightly higher than the expected 5.2%; core CPI rose 0.4% month-on-month, in line with expectations and the previous value.
Federal Reserve officials will release a new quarterly economic forecast after Wednesday's meeting. Timiraos believes that they could use this opportunity to emphasize that if the economy and inflation do not show signs of slowing soon, they may raise interest rates further. Federal Reserve Chairman Jerome Powell will further explain officials' thoughts at a press conference on Wednesday.
Looking at the Federal Reserve officials' forecasts in March, most officials then expected that as long as economic growth and inflation slowed, they would only raise the federal funds rate to its current level, i.e., 5%-5.25%, and maintain it at this level by the end of the year. However, a considerable minority believe that the rate needs to increase to around 5.5%.
It is worth noting that when the Federal Reserve made the above forecasts in March, it was amid the outbreak of the banking crisis in the United States. Two medium-sized banks, Silicon Valley Bank and Signature Bank, declared bankruptcy on March 10 and March 12 respectively, and officials provided economic data forecasts on March 22. A few weeks later, the third troubled bank, First Republic, also declared bankruptcy.
Before the March meeting, Federal Reserve officials raised their estimates of the "peak rate" every quarter. However, affected by the banking crisis, more officials believed that the possibility of banks tightening credit could have the same effect as the Federal Reserve raising interest rates. Most officials kept their predictions of the "peak rate" unchanged in March.
Since the outbreak of the banking crisis, some Federal Reserve policymakers have expressed concern that the economy did not respond to the rapid rate hikes of the past year and therefore wish to continue raising rates to ensure a quick economic slowdown. But other officials worry that past rate hikes have not fully transmitted to the economy. The banking crisis is an early example of how loan retractions can occur unnoticed, especially considering that the financial market has been accustomed to historically low borrowing costs for the past decade.
Timiraos stated that the resilience of the U.S. economy and the lagged effects of rate hikes are intertwined, making any interest rate policy more dangerous at this time of short-term interest rates being at a 16-year high compared to the early straightforward rate-hiking stage.
Quoting former Federal Reserve governor Jeremy Stein, Timiraos warned that the risk of making mistakes in monetary policy has increased. He also cited former Federal Reserve governor Daniel Tarullo, saying that planning the magnitude and speed of rate hikes requires a different, more complex analysis, not just relying on the latest inflation data and employment reports.
After swiftly raising interest rates from zero last year, the Federal Reserve has slowed its pace this year. So far this year, they have raised rates by 25 basis points at each of their three meetings. The current rate hike cycle by the Fed has seen 10 consecutive hikes. Pausing this week means that Federal Reserve officials are further slowing the pace of rate hikes to assess the impact of previous hikes and any effects of the banking crisis.
However, Timiraos pointed out that signaling a "skip" in rates, i.e., keeping rates steady in June while indicating a high likelihood of a hike in July, might be challenging to explain to the public.
One of the challenges faced by the Fed is that economic activity continues to exceed expectations. For instance, low inventory of existing homes in recent months has been driving new home sales and price increases. However, Fed policymakers have not had much time to assess to what extent (if at all) the continually rising financing costs of banks are reducing lending. Compared to traditional rate hikes, the economic impact of banking and other financial pressures is harder to measure using models.
Those who believe that the Federal Reserve should continue to raise rates are more concerned about high inflation becoming entrenched in the public mind. The experience of high inflation in the 1970s showed that once people expect price rises, the Fed has to force unemployment rates to rise to suppress inflation. If people think that due to concerns about the banking system, the Fed is unwilling to raise interest rates to fight inflation, this could lead to inflation expectations rising.
Former Minneapolis Federal Reserve Chairman Narayana Kocherlakota criticized the Federal Reserve for continuing to peddle the idea that interest rates do not need to rise significantly. "Does the Fed have to raise rates to 7%? I hope not. Is it possible that they will have to raise rates to 7%? Absolutely," he said.
