The officials at the Federal Reserve are pushing back against investor impressions that the central bank will soon reverse its campaign of raising interest rates to combat inflation. With recent reports indicating a decline in inflation, traders are heavily anticipating that the central bank will cut the key interest rate at some point in the coming months rather than continue to raise it from its current level, which is the highest in 22 years. Traders have priced in a 14% chance of a rate cut in January. The interest rate affects borrowing costs for things like credit cards and mortgages, so a rate cut would reduce those costs. Interest rates have already declined due to easing inflation concerns, as well as the growing belief that the central bank is about to lower rates.
Is the Federal Reserve preparing to reverse its campaign of raising interest rates to combat inflation?
The answer depends on whether you ask market watchers or the officials who are actually making the decisions about monetary policy. As of Friday, markets were pricing in a 14% chance that the central bank would cut rates by January, according to the CME Group’s FedWatch tool, which forecasts interest rate movements based on futures market trading data. Meanwhile, Federal Reserve Chair Jerome Powell and other policymakers at the central bank confirmed in their speeches this week that the central bank could raise the key interest rate again if inflation does not continue its recent downward trajectory.
The impact of rate cuts on the economy and markets
The central bank raised the interest rate 11 times between March 2022 and July, keeping it at the highest level in 22 years, which increased borrowing costs across all types of loans in an attempt to curb spending and slow down the economy to eliminate inflation that reached a 40-year high in the summer of 2022. With inflation significantly declining since then – approaching the central bank’s annual target of 2% – Federal Reserve watchers are speculating on when the first rate cut will happen, with less focus on whether there will be further increases.
The central bank is widely expected to keep the interest rate unchanged in December, rather than raise it, due to rapidly declining inflation in recent months. Federal Reserve officials have also acknowledged that excessive tightening in raising interest rates to combat inflation could significantly slow the economy and lead to unnecessary job losses, putting the economy at risk of recession.
Powell dismissed speculation about rate cuts on Friday while delivering a speech at Spelman College in Atlanta. He stated, “It would be premature to confidently conclude that we have achieved a sufficiently restrictive stance, or to speculate on when to ease policy,” according to prepared remarks. “We are prepared to tighten policy further if appropriate to do so.” Powell and other officials may be concerned that the financial markets’ response to the prospect of a rate cut could undermine efforts to combat inflation by pushing stock prices higher and reducing interest rates.
This has already happened to some extent – the yield on the 10-year Treasury bond, which is closely related to interest rates on all types of loans, has dropped by 4.2% as of Friday after exceeding 5% in late October. The average rate offered for a 30-year fixed mortgage has also fallen from its recent peak, dropping to 7.22% this week after reaching 7.79%, its highest level since 2000, in late October, according to Freddie Mac.
Probability
Raising Interest Rates If Inflation Does Not Continue to Decline
Thomas Barkin, the CEO of the Federal Reserve Bank of Richmond, said in an appearance on CNBC this week that raising interest rates is still a possibility if inflation does not continue to decline. Michelle Bowman, one of the Federal Reserve Board members, stated that she believes it is likely that interest rates will be raised again.
Bill Nelson, the chief economist at the Bank Policy Institute, wrote in his commentary: “While their baseline expectations include a slight rate cut next year, they seem understandably concerned that if they communicate that they are done tightening, the markets will focus exclusively on cuts.” He added: “To push things back, they are mainly focusing on the possibility of rate increases rather than having balanced risks.”
However, one Federal Reserve official predicted a rate cut. Federal Reserve Governor Christopher Waller this week said in a speech to the American Enterprise Institute, a conservative think tank in Washington: “It’s not about trying to rescue the economy from recession; it aligns with every policy rule I know from my academic life and as a decision-maker — if inflation goes down, I will cut the interest rate.”
Waller’s statement may carry more weight in markets due to his reputation as a “hawk” leaning towards supporting higher interest rates. Douglas Porter, the chief economist at BMO Capital Markets, commented: “Given that Waller has been a hawk in the past, these statements have really caught the market’s attention, even if the words were not particularly surprising. Other Federal Reserve officials have tried to cool the fires a bit, bravely suggesting that raising interest rates is still possible in the event of inflation disappointment, but investors have ignored those remarks.”
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Article Sources:
CME Group. “FedWatch Tool.”
Federal Reserve. “Opening Remarks, Federal Reserve Chair Jerome Powell, at a fiery conversation at Spelman College, Atlanta, Georgia.”
CNBC. “10-Year Treasury Bonds.”
Freddie Mac. “Mortgage Rates Decline for the Fifth Consecutive Week.”
CNBC. “Barkin of the Fed says raising interest rates is still possible if inflation does not continue to decline.”
Federal Reserve. “Reflections on the Economy and Monetary Policy, Federal Reserve Governor Michelle Bowman.”
American Enterprise Institute. “The Federal Reserve and Economic Outlook: A Conversation with Federal Reserve Governor Christopher J. Waller.”
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