Federal Reserve Chair Jay Powell is facing a difficult balancing act to maintain flexibility within the US central banks policy plans, despite intense pressure from the US government to reveal the date and amount of interest rate cuts planned for next year.
Powell faces a mixed economic outlook as the Federal Open Market Committee (FOMC) prepares to meet for its final 2-day meeting of 2023. The labor market and consumer spending are strong, but there are signs that growth is slowing and inflation is lower as a result.
In this context, the Federal Reserve will hold interest rates at their third meeting in a line and maintain the federal funds rate to a 22-year-high of 5,25-5.5 percent.
Officials aren’t ready to declare that interest rates have been “sufficiently restrictive”, to bring inflation to the 2% target. They are also not ready to discuss more publicly the conditions under which they will lower borrowing costs in 2019. This goes beyond simply addressing price pressures.
Powell faces a challenge this week because the financial markets do not believe his warnings about additional monetary tightening. Investors think that the world’s biggest economy has already slowed enough to eliminate the need for any further rate increases. They are also convinced that the Fed will be forced to lower interest rates earlier than expected by incoming data.
In recent weeks financial conditions have loosened, raising fears that the Fed is compromising its efforts to reduce demand.
Ellen Meade is a former senior adviser for the Fed’s Board of Governors and now teaches at Duke University. It’s a sensitive time, because the financial conditions play a major role in this.
At a Wednesday press conference, the chair will be able to reinforce the Fed message once more. He is expected to say that it is “premature to declare an imminent policy pivot” even though inflation is continuing to moderate. Powell said that the central bank will only make decisions “carefully”.
Before the Fed chairman takes to the podium, it will release a statement of policy and a set of economic projections, which aggregates the individual forecasts by officials for interest rates and growth, as well as unemployment and inflation.
The Fed is expected to keep its statement the same, which means it will include the line that outlines the conditions they will consider to determine the “amount of additional policy firming” necessary to bring inflation back to 2% over time. They argue that removing this could send a too direct message to the public that the Fed has indeed completed the rate-raising stage of its historic campaign.
The projections, which were made in September and predicted a federal funds rate of 5.5-5.75 percent this year, before falling by half a point in 2024, will be closely watched to see if the officials have added in any more cuts.
If the Fed maintains the same level of reductions next year, it will help to clarify that they are not planning a sudden reversal of course despite a slowdown in the rate of price increases. Some economists suggested that officials may indicate an additional quarter-point reduction in 2024 to reflect a more benign outlook for inflation.
Matthew Raskin is a former senior employee of the Federal Reserve Bank of New York and now the US head of rates at Deutsche Bank. He said that any more signals could complicate the situation for the Fed.
He said that once you get beyond this point, it is difficult to maintain that you are not near the point of considering cuts or speculating about it. Deutsche anticipates that the central bank will cut its policy rate next year by 1.75 percentage points, starting in June. Morgan Stanley economists also think the Fed will begin to lower rates in 2024, but by only 1 percentage point.
Constance Hunter, of MacroPolicy Perspectives, said that officials will be flexible in the next phase of their fight against inflation. Powell made this clear in his last public appearance prior to the December meeting. He said that he would “let the data show the right path”.
Hunter stated that “They won’t go from tightening and easing to neutral bias, but will instead take a step backwards.” They would like to get to that stance as soon as the inflation data permits, because they are aware that policy lags still haven’t played out fully and will continue to impact the economy.