Here is the good news.
After the most aggressive interest rate hikes in 40 years, the Federal Reserve is expected to approve a final quarter-point increase on Wednesday and signal a long overdue pause, economists say.
The prospect of an end to interest rate increases should come as a welcome relief to consumers and businesses grappling with rising borrowing costs. It could ease the concerns of investors hurt by the market-disrupting fallout from the 13-month campaign of interest rate hikes. Any sign of a halt would come sooner than expected and confirm that the recent failures of Silicon Valley Bank and Signature Bank have been a kind of price hike by curbing lending, economic growth and, most importantly, inflation..
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Now, the not so good news.
The Fed does not intend to display the “Mission Accomplished” banner. She is expected to say that she is ready to raise interest rates further if inflation and the labor market do not calm down as expected. And the central bank is likely to confirm that it does not plan to cut interest rates this year, as markets expect, even in the event of a widely expected recession. Federal Reserve officials do not expect rate cuts until 2024.
“They’re not afraid of a shallow recession,” says Jonathan Millar, an economist at Barclays. “They want to avoid causing a deep recession.”
Will the Fed raise interest rates again this year?
In other words, the Fed is likely to signal that while it’s pausing, it’s preparing to raise or lower interest rates this year, but is more likely to raise them, Millar says.
Economists expect the Fed to remove guidance in its statement after the meeting in March that “some additional (interest rate increases) may be appropriate” to bring inflation down to the Fed’s 2% target. Instead, Goldman Sachs expects the central bank to say rates are likely to be sufficient to meet that target, but the Fed will watch economic data closely to determine its next interest rate moves.
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Such a strategy wouldn’t come as a surprise. In March, the Fed predicted it would raise its key interest rate by another quarter point to a range of 5% to 5.25% and then halt anti-inflation efforts, which lifted the benchmark rate from near zero in early 2022.
Recent economic data presents a mixed picture for inflation. A government report last week revealed that the Fed’s preferred measure of inflation fell to 4.2% last month from a 40-year high of 7% last June. But the core measure that excludes volatile nutrients and energy remained higher than expected at 4.6%.
Also, a measure of wage growth showed that US employee pay and benefits rose 1.2% in the first quarter, beating the fourth-quarter pace and estimates by economists. Companies often pass higher labor costs on to consumers through higher prices.
What could cause the Federal Reserve to raise interest rates again?
“We believe a rally in June will come back into question if inflation’s advance stalls alongside strong employment gains in May,” Barclays wrote in a research note.
The Fed expects the annual core inflation rate to fall to 3.6% by the end of the year, according to its March forecast. Barclays says that would require monthly price increases averaging less than 0.3%. If data in the next few weeks shows inflation exceeding this pace, “that could be reason for another rally,” says the research firm.
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Likewise, monthly job growth slowed from 472,000 in January to 236,000 in March. Barclays says if May payroll hits the top 200,000, that could also lead to the Fed raising rates in the coming months.
However, Morgan Stanley also notes that such developments “must be weighed against information about bank lending and its economic implications.” Simply put, if the banking crisis restricts borrowing and the economy more than expected, the Fed will have to balance conflicting forces.
“It’s a tough proposition,” says Millar.
Why does the Federal Reserve cut interest rates?
Barclays says rate cuts this year are “extremely unlikely unless a large-scale financial crisis or a very large external shock hits the economy”.
Barclays expects the recession starting in the second half of the year to cause 800,000 job losses and push the unemployment rate from 3.5% to 4.9% by early 2024.
This represents a more moderate-than-average slowdown, Millar says, adding that it would take a sharper recession to prompt the Fed to cut interest rates this year.
“We think a mild recession will unfold[later this year]but the Fed won’t be able to respond with rate cuts because inflation will remain high and steady,” says Kathy Bostancic, chief economist at Nationwide Mutual.
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