Rate Hikes: US Federal Reserve may be nowhere near done yet

Federal Reserve policymakers decided to forgo any move in their policy rate Wednesday, leaving the target at 5 percent to 5.25 percent to allow time to assess the impact of past monetary tightening. But they are still feeling their way around in the dark to identify the level of rates that will bring down high and stubborn inflation, and the Fed’s Summary of Economic Projections suggests they’re not there just yet.

Notably, the median projection in the so-called SEP — released simultaneously with Wednesday’s rate decision — increased even more for the fed funds rates than it did for projected inflation, implying that the committee sees a need for greater real rates to put sufficient restraint on the economy. A year ago, the Fed thought it could fight inflation by getting policy rates about 1.1 percentage points above projected inflation, but committee members have clearly started to reconsider that. Now, the typical policymaker seems to think that “real rates” will need to be as much as 2 percentage points above inflation in 2024.

The implication is that rates could remain quite elevated even if disinflation picks up steam later in the year.

The phrase “sufficiently restrictive,” of course, is one of those purposely vague entries in the Fedspeak lexicon that’s hard to define with any precision. You can try to quantify it (as I have above), but it’s constantly changing alongside the ever-shifting profile of the US economy. For his part, Fed Chair Jerome Powell was circumspect at his press conference on Wednesday about the level of rates that would be “sufficiently restrictive.” Asked about it by CNBC journalist Steve Liesman, he demurred on specifics: "What we’d like to see is credible evidence that inflation is topping out and then beginning 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 – we understand that there are lags. But remember that it’s more than a year since financial conditions began tightening. I think the reason we’re comfortable pausing is much of the tightening took place last summer and later into the year, and I think that it’s reasonable to think that some of that may come into effect."

Adding to the confusion is the notion that policymakers revised up their implied estimates of “sufficiently restrictive” at the same time that they unanimously paused interest-rate increases. As the Wall Street Journal’s Nick Timiraos asked Powell Wednesday, why not raise now if you know you have more work to do? In his response, Powell said that the speed of tightening and the right levels were somewhat separate questions: "Speed was very important last year. As we get closer and closer to the destination, and according to the SEP we’re not so far away from the destination in most people’s accounting, it’s reasonable, it’s common sense to go a little slower."

It’s also true that the Fed seemed to box itself in. In the weeks after the last policy meeting, several officials strongly signaled an intention to “skip” a meeting in June. The Fed is generally reluctant to surprise markets, so they were hamstrung to follow through once the “skip” had been priced in.

While Powell was able to fend off any formal dissents at Wednesday’s meeting, the SEP suggests that some policymakers are clearly getting uncomfortable with the way that inflation is reacting — or failing to react — to the 500 basis points of rate increases since March 2022. The top “dot” in the SEP — which also features an anonymised “dot plot” of individual committee members’ forecasts — showed a risk of rates having to go to 6 percent to 6.25 percent. By and large, the Fed’s preferred inflation measure — the core personal consumption expenditures deflator — has essentially shown a steady rate of price increases for much of the past year. By that measure, inflation isn’t accelerating, but it’s not coming down, either. Meanwhile, there are some signs that the rate-sensitive housing market may have started to rebound a bit, and the job market remains fairly resilient.

There will always be some people who believe that policymakers 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’s 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 “hawkish” projections to guard against that. While the main core inflation indexes have remained stubbornly high, there are clearly some hopeful developments under the hood, and it may simply take time for them to work their way through.

Whatever the case, Fed policymakers are signaling that they think the level of “sufficiently restrictive” policy rates is higher — in real terms — than previously thought. And if the past year has taught markets anything it’s that it pays to listen.

Jonathan Levin has worked as a Bloomberg journalist in Latin America and the U.S., covering finance, markets and M&A. Most recently, he has served as the company's Miami bureau chief. He is a CFA charterholder. Views are personal and do not represent the stand of this publication. Credit: Bloomberg