Is the war on inflation over?: Fed’s Powell will offer clues



“The descent is often more treacherous than the ascent of a mountain,” said Diane Swonk, chief economist at KPMG and a regular attendee of the exclusive Fed confab. “It’s littered with potholes, and they don’t want to trip.”

The stakes are high. The economy has proved to be surprisingly resilient, but Fed officials are wrestling with often conflicting information to decide whether to keep raising interest rates and how long they need to keep them at high levels to ensure that the worst price spikes in four decades are fully over. A wrong calculation could trip the economy into a slump.

The question is beginning to divide the central bank’s rate-setting committee, which so far has been in lockstep on policy decisions. Some members have been voicing increasingly divergent views about whether the economy can slow without a big jump in unemployment — the so-called soft landing that has proved so elusive in the past.

Heading into his closely watched speech, Powell’s message is likely to be one of vigilance as the central bank aims to bring inflation back down to its 2 percent target. The central bank chief doesn’t want to jolt markets, which have lately been aiding the Fed’s campaign to slow spending and investment. Bond yields have risen markedly in the past few weeks, raising borrowing costs for consumers and businesses, as investors accept that the central bank will be keeping rates high for a while.

Fed officials have indicated that they’re worried about raising rates too high and causing an unnecessarily sharp downturn, which could suggest growing “dovishness,” or less emphasis on inflation going forward. But at least one more rate increase is still on the table for this year, and Powell has repeatedly underscored that the battle is not won.

Indeed, the Fed’s rate-setting committee will get additional reports on both inflation and jobs before the next rate decision in September.

“You don’t want to come out with a speech that is so dovish that the stock market rallies massively, but you also don’t want to spook the market with something that is so hawkish that you get an outsize reaction,” said Brett Ryan, senior U.S. economist at Deutsche Bank. “Say less, not more.”

Investors will be watching closely for any signals from Powell about how much the Fed thinks the current level of rates is biting into growth, and how much the central bank might lower rates over the next couple of years as inflation drops — a topic he might be hesitant to touch on in any detail.

Even if the Fed does not end up increasing rates again this year, officials aren’t forecasting rate cuts until sometime next year, when they hope inflation will more clearly come back down toward 2 percent.

“They’ve been pretty clear about we’re going to stay higher for longer,” said Claudia Sahm, a former top economist at the Fed.

The labor market is holding steady, with the unemployment rate at 3.5 percent, and consumers are still spending. That suggests there’s still a risk that the economy is so strong that inflation may rise again.

“The fact that it looks like the economy is reaccelerating right now is something they have to be mindful about,” KPMG’s Swonk said.

But the job market also appears to be cushioning the economy from a worse fate as household bank accounts are slowly being depleted, with mortgage rates approaching 8 percent and credit card debt hitting a record high of $1 trillion. That’s renewed hopes among economists that the unemployment rate won’t actually have to jump significantly, something that Powell last year clearly hinted might need to happen.

“When it became clear you had an inflation problem, the prescription was very simple: Start hiking aggressively,” Deutsche’s Ryan said. “The hardest part of policy is trying to engineer that soft landing.”



Source link: https://www.politico.com/news/2023/08/24/treacherous-descent-fed-debates-how-far-to-push-rate-hikes-00112484

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