Economists detect more uncertainty at the central bank
An interest-rate cut at the Federal Reserve’s June meeting, though now widely expected, should not be viewed as decision that has already been made, Fed watchers say.
When Fed Chair Jerome Powell’s press conference ended last Wednesday, expectations that the Fed would cut rates in June shot higher, ending the week at a 67% chance in futures markets, up from just above 50% earlier in the week, according to the CME Group.
But economists think the bond market is getting ahead of itself.
“The bond market has expected them to move a little early the whole time. I wouldn’t be surprised if they wait one more meeting [until July],” said Ethan Harris, retired chief global economist at Bank of America.
The January and February consumer inflation readings were “two bad months,” and they need three friendly reports before they’re ready to pull the trigger. “That may not be in time for June,” Harris said.
“So I think that’s where the debate should be. June or not,” he said in an interview.
J. Benson Durham, head of global policy and asset allocation at Piper Sandler, agreed.
“I think it is too soon the say that June is locked in and baked in the cake,” Durham said in an interview. “I still think the data is kind of volatile.”
Uncertainty about the economic outlook is higher than it’s been since the 1970s, Durham said.
Derek Tang, economist at Monetary Policy Analytics, said uncertainty about the path of the economy has become more pronounced.
“I think they are a little wary that inflation is going to stay stubborn at levels above 2%,” he said. “That’s why they are kind of proceeding quite carefully.”
Markets celebrated last week when the Fed maintained its projections of three interest-rate cuts this year. For the week, the Dow Jones Industrial Average DJIA rose 2%, the S&P 500 SPX climbed 2.3% and the Nasdaq COMP advanced 2.9%.
Many Fed watchers believe Powell downplayed recent strong inflation data. This was seen as a sign he is willing to cut rates and is waiting to convince his colleagues to make a move.
“Powell left little doubt about his intent to start cutting rates in the not-too-distant future,” said Michael Feroli, chief U.S. economist at JPMorgan Chase.
“My sense is still that the Fed has itchy fingers to start cutting rates, and I don’t fully get it,” said former Treasury Secretary Lawrence Summers, in a television interview.
The trouble is that Powell’s colleagues may not be fully on board with a move.
“There is a swelling group of Fed officials that believe rates may need to be higher for longer,” said economists at Jefferies, in a note to clients.
This group came to light in the economic forecasts released by the central bank, the firm said.
Seven of 19 Fed officials said that the “neutral rate” is above 3%. That suggests they believe the Fed’s current policy rate is not very restrictive on the economy.
Jeremy Schwartz, senior U.S. economist at Nomura, said that Powell’s dismissal of unfavorable inflation creates the risk that further upside inflation surprises could lead to a sharper reassessment of the path for policy.
Schwartz sees only two cuts this year, one in July and the second in December.
The Fed’s next policy meeting is April 30-May 1. Economists generally believe that Powell would want to use that meeting to “tee up” cuts at the next meeting June 11-12.
Tang said it was clear the Fed wants to get started cutting rates, but might stop after the first few and see how the economy is responding.
At the same time, the Fed is getting more worried about a recession, he said, with the central bank not seeing inflation getting back to its target until 2026.
“It’s not that a recession is immediate. But they don’t want that risk to creep up. And they’re willing to hold down that recession risk at the cost of slightly higher inflation for the next few years,” he said.
Feroli said there is a chance that the Fed cuts rates more quickly than anyone expects.
He noted that Powell added a new phrase to his remarks, saying that “an unexpected weakening in the labor market could also warrant a policy response.”
Feroli said that if there was a weakening in labor markets, “the pace of rate cuts would be sped up to every meeting, or, if the weakening were sharp enough, the size of the rate cuts would be increased.”
On Friday, Powell will be interviewed by Kai Ryssdal, the host of “Marketplace,” a program about business and the economy that airs weekdays on U.S. public radio stations.