Powell Will Likely Signal That Lower Inflation is Needed Before the Fed Will Cut Rates

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WASHINGTON (AP) — After three consecutive better-than-expected inflation reports, Federal Reserve officials have become more cautious about the prospect of rate cuts this year. The big question after their final policy meeting on Wednesday will be: Will they signal any rate cuts at all this year?

Wall Street traders now expect just a single rate cut this year to the Fed’s key interest rate, which is now at a 23-year high of 5.3% after 11 hikes ending last July. Traders have cut their expectations significantly since the start of 2024, when they expected up to six rate cuts.

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At the last Fed meeting on March 20, policymakers themselves had forecast three interest rate cuts in 2024. Fed rate cuts would lead to lower borrowing costs for consumers and businesses over time, including for mortgages, auto loans and credit cards.

Most economists say they still expect two cuts this year. However, many recognize that some or no tariff reduction is possible. That’s because elevated inflation is proving more persistent than almost anyone expected. According to the Fed’s preferred measure, inflation reached an annual rate of 4.4% in the first three months of this year, up from 1.6% in the final quarter of 2023 and well above the Fed’s 2% target.

At the same time, the economy is healthier and hiring is higher than most economists expected at the time. The unemployment rate has been below 4% for more than two years, the longest such rise since the 1960s. Consumers spent heavily in the first quarter of the year. As a result, Chairman Jerome Powell and other Fed officials have made it clear that they are in no rush to cut their key interest rate.

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In his most recent comments two weeks ago, Powell suggested that the pace of price increases had essentially undermined Fed officials’ confidence that inflation was steadily returning to its target, making rate cuts any time soon less likely. He also said the Fed would refrain from cutting interest rates as long as inflation remained high. However, he stopped short of suggesting that new interest rate hikes were being considered.

“If higher inflation continues,” the Fed chairman said, “we can maintain current levels (of interest rates) for as long as necessary.”

Most economists expect Powell to reiterate that message during the news conference he will hold after the Fed’s meeting on Wednesday. But he could go further.

For example, during his last press conference in March, Powell said that the Fed’s interest rate had “likely peaked” and that “if the economy performs broadly as expected, it will probably be appropriate” to start doing so later this year to begin cutting interest rates.

If Powell avoids repeating that sentiment this time, it could suggest the Fed is less likely to cut its key interest rate this year.

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“If this (message) is dropped, I think it would be a much stronger signal that we need to keep interest rates higher for longer,” said Jonathan Pingle, chief economist at UBS.

Although economic growth only reached an annual rate of 1.6% in the first three months of this year, a slowdown from the previous quarter, consumer spending grew strongly, a sign that the economy will continue to grow.

This continued strength has led some Fed officials to speculate that current interest rate levels may not be high enough to provide the needed cooling effect on the economy and inflation. If so, the Fed may even have to start raising interest rates again at some point.

“I continue to see the risk that we may need to raise (rates) further at a future meeting if progress on inflation stalls or even reverses,” Fed Board of Governors member Michelle Bowman said in early April.

On Wednesday, the Fed could also announce that it is slowing the pace at which it is unwinding one of its biggest measures of the COVID era: the purchase of trillions of dollars of Treasuries and mortgage-backed bonds, an attempt to stabilize financial markets and to last longer – term interest rates low.

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The Fed is now allowing $95 billion of these securities to mature each month without replacing them. Its holdings have fallen to about $7.4 trillion, compared to $8.9 trillion in June 2022, when tapering began.

By reducing its holdings, the Fed could help keep longer-term interest rates, including mortgage rates, higher than they otherwise would be. Because if the company reduces its bond holdings, other buyers will have to purchase the securities instead, and interest rates may have to rise to attract the needed buyers.

At their March meeting, a Fed official agreed to reduce the outflow rate to about $65 billion per month, according to meeting minutes.

The last time the Fed reduced its balance sheet was in 2019, it inadvertently disrupted financial markets and caused short-term interest rates to rise in September. The goal of slowing the rate at which the company reduces its bond holdings is to avoid a similar market disruption through a more methodical approach.

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