The US Federal Reserve holds rates steady, but lays the groundwork for a rate cut

U.S. monetary policy is at a turning point. The Federal Reserve believes it has already raised interest rates as much as it needed to control inflation. This Wednesday, it held rates at 5.25%-5.5%, the highest in almost 23 years, which the Fed has maintained since July. Now the time to lower rates is approaching. Jerome Powell, the chairman of the Federal Reserve, has begun to lay the groundwork for it, but he has also called for patience. The monetary policy committee is not confident enough that the battle against inflation has been won. “The committee does not expect that it would be appropriate to reduce the [interest rate] target range until it has gained greater confidence that inflation is moving sustainably toward 2%,” Powell has said, repeating the message of the Fed statement released shortly before.

“We believe that our policy rate is likely at its peak for this tightening cycle,” Powell explicitly conceded at the post-meeting press conference. “And that if the economy evolves as expected, it will probably be appropriate to consider lowering it sometime this year. But the economy has surprised forecasters in many ways since the pandemic and ongoing progress toward our 2% inflation objective is not assured. The economic outlook is uncertain, and we remain highly attentive to inflation risks,” he said. The Fed chairman cautioned that “we are prepared to maintain the current target range for the federal funds rate for longer if appropriate.”

The fact that the Federal Reserve believes rates will fall this year is not a secret. The committee members’ own forecasts, updated in December, pointed to a 0.75-point cut this year through the end of the year. The question is when and at what pace. Opinions were divided. The market was pricing based on the likelihood of a first rate cut in March, but after Powell’s warning on Wednesday, that possibility is fading.

Most analysts expect quarterly cuts of 0.25 points starting in the second quarter, beginning at either the May or June meeting. Powell’s message is still consistent with that scenario. In fact, at the press conference, Powell said it was “unlikely” that there will be a rate cut at the March meeting, but he did not rule out a rate cut in the first half of the year entirely.

“As labor market tightness eases and progress on inflation continues, the risks to achieving our employment and inflation objectives are moving into balance,” Powell explained. “We know that reducing monetary policy too soon or too much could result in a reversal of the progress made on inflation and ultimately require even tighter policy to bring inflation back to 2%. At the same time, reducing policy or diverting policy too late or too little could unduly weaken economic activity in employment,” he added.

“The economy has made good progress toward our dual mandate objectives,” Powell has said, referring to his goals of achieving maximum possible employment along with price stability. “Inflation has come down from its highs without a significant rise in unemployment. This is very good news,” he conceded. He then went on to emphasize that “inflation remains too high,” that “ongoing progress in reducing it is not assured,” and that “the way forward is uncertain.”

The economy grew 0.8% quarter over quarter and 3.1% year over year in the fourth quarter, showing surprising strength. For the year as a whole, gross domestic product (GDP) rose 2.5%, according to the first estimate released last Thursday by the Commerce Department’s Bureau of Economic Analysis. Meanwhile, the Fed’s preferred inflation gauge slowed to 2.9% in December, dipping below 3% for the first time since early 2021, according to data released Friday by the same agency.

When Powell was asked about whether he had achieved the economy’s soft landing, he preferred to be cautious: “Certainly, I’m encouraged and we’re encouraged by the progress,” Powell said. But “we’re not declaring victory at all at this point. We think we have a ways to go.” But whereas on other occasions he had indicated that it would be necessary to cause families and businesses “some pain” by weakening growth, his tone has changed now: “We want strong growth. We want to see a strong labor market. We don’t want a weaker labor market. We want inflation to continue to come down as it has been doing for the last six months,” he said.

In the last two years, the price of money has risen by just over five points, the most aggressive tightening of monetary policy since the 1980s, to counter the highest inflation in four decades. The central bank has not changed the rates since July of last year, but Powell has managed to keep up the pressure. He has pointed out on many occasions that, in this tightening cycle, how long rates remain high is even more important than how high the price of money goes.

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