The Fed's off-script remarks send an important message about interest rates
What was supposed to be a status quo Fed decision turned into a head-scratcher after chairman Jerome Powell seemingly went off-script in a post-meeting press conference.
On March 20, the Fed’s FOMC board voted to keep interest rates unchanged—a move that had been a foregone conclusion way ahead of the meeting. But what happened next had analysts scratching their heads.
In a post-meeting conference, Fed chief Powell reiterated their intention to cut rates three times in 2024, despite seemingly being behind schedule.
“We believe that our policy rate is likely at its peak for this type of cycle and that if the economy evolves broadly as expected, it will likely be appropriate to begin dialing back policy restraint at some point this year,” he said.
Even more surprising was his comments on the job market, which the Fed is trying to cool as part of its inflation fight.
“Strong hiring in and of itself would not be a reason to hold off on rate cuts,” Powell said.
Powell’s confidence took some market participants by surprise as investors were becoming increasingly skeptical about the Fed’s ability to cut rates this year due to stubbornly high inflation.
“This presser by Powell was extremely reckless,” said Gordon Johnson, a market analyst and founder of GLJ Research. “He is basically saying he is not data dependent, and will cut rates and slow QT, even if inflation goes higher and jobs are plentiful.”
Johnson said that the Fed is losing its credibility with investors by disregarding inflation and that, at some point, the bond market would make up its own mind.
“At some point, bond investors will disregard the Federal Reserve, and demand higher yields to compensate for what is clearly pending higher inflation. This is the danger of Powell being reckless,” he said.
What’s up with inflation?
Some economists are concerned that the Fed has already lost the inflation fight and is willing to accept higher consumer prices moving forward.
The consumer price index (CPI) has topped forecasts for three consecutive months, reaching an annual rate of 3.2% in February. Meanwhile, the all-important “core” inflation reading has exceeded estimates in back-to-back months.
Economist Peter Schiff said hotter than expected inflation “doesn’t mean that the Fed has to fight harder to win the inflation war, but that it’s already lost.”
In his view, the Fed can’t tame inflation without raising interest rates considerably, which would trigger a major recession. So, “in effect, the Fed brought a knife to an inflation gunfight,” he said.
In addition to rising consumer prices, economist Wolf Richter has flagged a “very disconcerting” acceleration in the producer price index (PPI), especially around services.
“Reheating services inflation isn’t a surprise. But the PPI for finished core goods saps hopes for goods “deflation” to continue to hold down overall inflation,” he said.
PPI measures so-called "wholesale inflation", or the prices paid by manufacturers. It’s considered a forward-looking indicator of consumer inflation because higher wholesale prices are eventually passed on to shoppers.
Commenting on rebounding inflation, Charles Schwab’s chief fixed-income strategist Kathy Jones said, “Through the volatility, the downtrend in inflation seems to be leveling off and the Fed would like to see it continue to move lower before easing rates.”
Of course, Jones’ remarks came before the Fed’s latest meeting—and Powell’s admission that interest rates are probably heading lower despite stubborn inflation.
Rate cuts in May or June?
Despite inflation being "stickier" than expected, former Boston Fed chair Eric Rosengren believes the central bank is on track to cut rates as early as May.
Commenting on the February CPI report, Rosengren said: “As long as wages and salaries continue to drift down, I don’t see this report really altering the overall view of probably a June reduction.”
Rosengren went as far as saying that he’d cut rates a month earlier, in May, because there are growing signs that the economy is cooling.
Markets seem to agree with Rosengren’s timing of a June rate cut. According to CME Group’s FedWatch Tool, futures traders say there’s a 73.5% chance of a rate reduction that month.
By September, only 3.5% of traders think the federal funds rate will remain at its current level of 5.5%, implying multiple rate cuts over that period.
Although rate cuts appear to be on the horizon, experts have cautioned against expecting a return to 0% for any extended periods.
“The days of ultra-low rates are over,” Agustin Carstens, the general manager of the Bank for International Settlements, said of major economies. In the future, “inflation will partly depend on factors that are not under central banks’ control.”