By Howard Schneider
WASHINGTON (Reuters) – As Federal Reserve officials last year started steering the world towards possible interest rate cuts in 2024, they took heart in data showing inflation over many months had collapsed to the U.S. central bank’s 2% target, evidence their policies were curbing a still too-hot economy.
Since then, those downward sloping lines have reversed in an economy that continues to grow above trend, produce enough jobs to keep unemployment at what many think is an unsustainably low level, and have pushed a core of at least four of the 12 Fed officials voting on monetary policy into a skeptical stance.
If the data doesn’t soon resume the trend that appeared to be developing last year, that group could grow and further undermine already weakening rate-cut expectations.
“When you start to see month after month of inflation not falling, and tipping up if you look at the six-month changes, I think that has given the Fed pause … There has been a change in sentiment,” said Karen Dynan, a Harvard University economics professor and a non-resident senior fellow at the Peterson Institute for International Economics.
While Fed officials might sketch out arguments for continued inflation declines based on “special stories” about housing or other parts of the economy, “when you rely on a whole bunch of special stories breaking your way, it is not a comfortable place,” said Dynan, who sees the central bank remaining largely on the sidelines this year, perhaps approving only a single quarter-percentage-point cut in rates.
That’s well short of the three quarter-percentage-point cuts Fed officials projected last month, an outlook largely shared by investors. But if the year began with rate cuts expected sooner than later, the burden of proof appears to have shifted.
Since the March 19-20 policy meeting, members of the Fed’s rate-setting committee, including two governors and two regional reserve bank presidents, have detailed concerns about the inflation path, a sizeable group in a consensus-minded organization that realizes the symbolic weight the start of policy easing will have on markets and, in a presidential election year, the broader public.
‘NO RUSH’
The release on Wednesday of the consumer price index (CPI) for March looms large in that regard.
Richmond Fed President Thomas Barkin told Reuters last week that another month of disappointing data after higher-than-expected readings in January and February could change things significantly. The minutes of the March meeting will also be released the same day, possibly detailing emerging policy divisions.
“I don’t think any one month should make that much of a difference,” said Barkin, one of the five regional bank presidents with a vote this year on rates policy. But “if you get another month that looks like January or February, that takes you in a very different direction in terms of how forward-leaning you are.”
The fact that half of the items in the CPI are still seeing price increases of greater than 3% is “hard to reconcile … with the kind of progress you’d want to make” towards the 2% target.
The annualized six-month change in CPI excluding food and energy prices – considered a reliable guide to underlying inflation – has risen steadily from 3.08% last November to 3.85% in February.
That upturn – seen also in the measure the Fed uses for its inflation target – interrupted a benign run of readings through much of last year that prompted policymakers to start laying the groundwork to cut the benchmark overnight interest rate from the current 5.25%-5.50% range, where it has been since last July.
“Something appears to be giving, and it’s the pace of the economy,” Fed Governor Christopher Waller said in a speech in November in which he said the central bank was potentially just a few months from being able to cut rates to account for falling inflation.
The economy, however, has continued to grow above trend since Waller’s remarks, and what appeared to be ebbing job growth has turned higher. Neither are inflationary developments on their own, but neither do they show an economy necessarily in need of lower interest rates, and the countdown to rate cuts that Waller helped touch off is effectively on hold.
“There is no rush to cut the policy rate” Waller said in a speech last month, arguing “it is prudent to hold this rate at its current restrictive stance perhaps for longer than previously thought to help keep inflation on a sustainable trajectory toward 2%.”
‘ELEVATED’ DATA-DEPENDENCE
Fed Governor Michelle Bowman, perhaps the most ardent inflation hawk, has gone even further, saying last week that rate hikes could not be ruled out, although they are not her base case.
Atlanta Fed President Raphael Bostic, meanwhile, said after the March policy meeting that he had cut his outlook from two rate cuts over the second half of 2024 to a single move late in the year.
The views of those voting policymakers is consistent with a general tempering of officials’ rate-cut expectations. Fed policymaker projections released in March did not change the median outlook for three rate cuts this year, but the full range of estimates and the “central tendency” – excluding the three highest and lowest projections – narrowed as the most dovish policymakers all raised their outlooks for the policy rate.
Even the more skeptical Fed officials say their baseline remains that inflation will slow and rates will fall if it does.
But it has also given the next month or two of data “an outsized role” in determining if the Fed gains the confidence it needs to cut rates, or loses faith that inflation is contained, said Krishna Guha, vice chairman at Evercore ISI.
“The hurdle is not crazy severe and the odds are the data will come in good enough” for the Fed to cut rates in June, he wrote, but “the Fed has slipped into a phase of elevated data-point dependence.”
