The Federal Reserve is this week set to discuss whether to increase the pace of its monetary tightening in the face of worsening inflation.
The Federal Open Market Committee will convene on Tuesday for a two-day gathering just days after two economic reports suggested that price pressures have become more relentless than expected.
Before data on Friday — which showed prices jumped another 1 per cent in May from the previous month and consumers became increasingly worried that high inflation will remain a problem for longer — the Fed had signalled it was poised to approve a second consecutive half-point rate increase. It would be the first time since 1994 that the US central bank has opted to raise rates by that amount at back-to-back meetings.
But another move last employed in 1994 is also now likely to be under consideration: raising rates by 0.75 percentage points.
Markets have fully priced in that outcome, following a report by The Wall Street Journal that suggested officials will discuss that possibility this week. JPMorgan’s chief economist Michael Feroli has raised the bank’s call for the upcoming meeting to a 0.75 percentage point increase.
Krishna Guha, vice-chair at Evercore, said such a move was “not what we think is optimal policy, and, separately, not in our view good for markets”, which were battered on Monday by rising inflation fears.
Economists are grappling with what lies ahead beyond the meeting, as the central bank confronts more inflation shocks that have raised doubts over whether it is moving swiftly enough to address what is already becoming an intractable problem.
The Fed has committed to moving “expeditiously” to a neutral setting — one that neither stimulates nor slows down growth — although chair Jay Powell recently conceded that threshold was “not something we can identify with any precision”. Rather, he vowed to keep pressing ahead until there was “clear and convincing” evidence that inflation was moderating.
US central bankers will convey their forecasted policy path in an updated “dot plot” to be released on Wednesday, which maps out individual interest rate projections as part of a broader set of estimates about the economic outlook. In its most recent set of projections, published in March, top officials pencilled in a benchmark policy rate of 1.9 per cent by year-end, and 2.8 per cent in 2023.
Policymakers are also due to publish updated forecasts for inflation, growth and unemployment, which are expected to reflect Powell’s recent admission that moves needed to tame price pressures will lead to “some pain”.
Economists had taken issue with March’s estimates, which suggested little movement in the unemployment rate from historically low levels even as policy became significantly tighter.
Powell has since acknowledged that the unemployment rate was likely to rise “a few ticks” and that the central bank may only be able to achieve a “softish” landing for the economy — a message Gargi Chaudhuri, head of iShares investment strategy for the Americas at BlackRock, chalked up to: “We can’t go all guns blazing now without some spillover.”
Economists had broadly expected the median unemployment rate forecast to reach about 3.8 per cent by 2024, 0.2 percentage points higher than its current level, with officials pegging inflation closer to 5 per cent this year.
A more substantive slowdown in gross domestic product growth is also anticipated. That in turn has increased the odds that some policymakers will predict outright rate cuts in 2024, reflecting the belief that the economy will have slowed notably by then.
A recent poll of leading academic economists by the Financial Times showed that nearly 70 per cent believed the US economy will tip into a recession next year.
Priya Misra, head of global rates strategy at TD Securities, said the Fed was confronting a much more difficult problem than just a few months ago. “They have two-sided risks now with growth and inflation,” she said.
For Stephanie Aaronson, another former Fed staffer now at the Brookings Institution, the central bank will need substantial luck to avoid a hard landing.
“If they don’t get much help on the supply side in terms of relief on energy and food prices . . . and they really have to do a lot more of the work on bringing down inflation themselves, they would not be able to do that with a soft landing.”