Fed may push rates higher, keep them there longer, policymakers say

NEW YORK: Federal Reserve policymakers may need to lift US borrowing costs above the peak 5.1 per cent they penciled in just this week, and keep them there perhaps into 2024 to squeeze high inflation out of the economy, three of them signaled on Friday.
 
The hawkish messages, delivered in separate appearances by New York Fed President John Williams, San Francisco Fed President Mary Daly, and Cleveland Fed President Loretta Mester, underscore the US central bank’s determination to do what it takes to ease price pressures that erode wages and strain household budgets, despite what analysts say could be a million or more jobs lost in the process.
 
They also stand in stark contrast with expectations expressed in financial markets. Traders on Friday leaned into bets that the Fed policy rate will peak below 5 per cent and the Fed will start cutting rates in the second half of 2023 to cushion what the New York Fed’s own internal model suggests will be an economic downturn.
 
New York Fed chief Williams said he’s not expecting a recession, but told Bloomberg TV “we’re going to have to do what’s necessary” to get inflation back to the Fed’s 2 per cent target, adding that the peak rate “could be higher than what we’ve written down.”
 
The Fed this year has raised rates from near zero in March to a range of 4.25 per cent to 4.5 per cent in the steepest round of rate hikes since the 1980s, the last time it battled fast-rising prices. Inflation by the Fed’s preferred measure is currently running at 6%, three times its 2% target.
 
Earlier this week as policymakers delivered the latest rate hike they also published projections that signaled nearly all of them see the need to lift rates still further, to at least a 5 per cent to 5.25 per cent range, in coming months.
 
That view surprised investors who earlier in the week had been heartened by data showing a second straight month of cooling inflation that some took to suggest the Fed’s round of rate hikes was near being done.
 
On Friday, the broad S&P 500 stock-market index closed down about 2 per cent on the week as the Fed’s more hawkish stance sunk in. Bond traders meanwhile appear to be quite convinced the Fed will indeed beat inflation.
 
Fed policymakers have welcomed inflation’s recent deceleration, driven by easing supply chain problems and higher interest rates restraining the housing market.
 
But they are also uneasily eyeing the strong labor market as a source of persistent price pressure.
 
US employers have added hundreds of thousands of jobs each month and the unemployment rate is at a low 3.7 per cent. Workers are in short supply, particularly after millions retired early on in the pandemic, and wage growth is running well beyond what the economy can sustain, policymakers say.
 
“I don’t quite know why markets are so optimistic about inflation,” San Francisco Fed’s Daly said, adding that it may be because markets are pricing in an ideal scenario. Central bankers, she said, are positioning policy for what she said were still “upside” risks to the inflation outlook.
 
Central bankers have become increasingly blunt that bringing inflation down will require a labor market slowdown that they will not try to offset with interest-rate cuts until they are confident they have beaten back inflation.
 
Over the past several rate-hiking cycles, the Fed raised rates and kept them there for an average of 11 months before cutting them.
 
“I think 11 months is a starting point, is a reasonable starting point. But I’m prepared to do more if more is required,” Daly said, adding that exactly how long will depend on the data. She said her own forecast for rates is in line with the 5.1 per cent peak rate expected by the majority of her colleagues.
 
The Fed has signaled “ongoing” rate hikes ahead, and Daly’s remarks suggests she sees rates staying high into the first couple of months of 2024 – even as the Fed predicts the unemployment rate will rise to 4.6 per cent, an increase that analysts say could mean the loss of 1.5 million or more jobs.
 
As of last month, central bank staff economists viewed the risks of recession against continued growth as roughly even, minutes from the Fed’s November policy meeting show.
 
Meanwhile, on Thursday, the New York Fed said its internal economic model sees a 0.3 per cent decline in overall activity next year and flat growth in 2024, with a return to positive growth the year after.
 
Fed policymakers this week forecast GDP growing about a half-a-percent next year.
 
While not a recession per se, such slow growth means an unexpected shock could easily trigger an outright contraction for a couple of quarters, Cleveland Fed’s Mester told Bloomberg TV.
 
She identified herself as one of seven of the Fed’s 19 Fed policymakers who see rates needing to rise even higher than the 5.1 per cent median in the Fed’s projections published this week.
 
In his news conference after the end of the Dec 13 to Dec 14 policy meeting, Fed Chair Jerome Powell nodded to the challenges that higher unemployment, if not necessarily a recession, would pose.
 
“I wish there were a completely painless way to restore price stability,” he said. “There isn’t, and this is the best we can do.”

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