The Federal Reserve is this week set to discuss whether to increase the pace of its monetary tightening in the face of what looks to be worsening inflation.
The Federal Open Market Committee convenes on Tuesday for a two-day gathering just days after two economic reports suggested that price pressures have become more relentless than expected.
Before the data on Friday — which showed prices jumping another 1 per cent in May from just a month ago and consumers becoming increasingly worried that high inflation will remain a problem for longer — the Fed had signalled it was poised to approve a second consecutive half-point rate increase. It would be the first time since 1994 the US central bank has opted to raise rates by that amount at back-to-back meetings.
But another tool also last used in 1994 is now likely to be under consideration: raising rates by 0.75 percentage points.
Markets have now fully priced in that outcome, following a report by The Wall Street Journal that suggested officials will this week discuss that possibility.
JPMorgan’s chief economist Michael Feroli has raised the bank’s call for the upcoming meeting to a 0.75 percentage point increase. Krishna Guha, vice-chair at Evercore, said it is “not what we think is optimal policy, and, separately, not in our view good for markets”, which were battered on Monday by rising inflation fears.
Economists are also grappling with what lies ahead beyond the meeting, as the central bank confronts more inflation shocks that have raised doubts over whether it is moving swiftly enough to address what is already becoming an intractable problem.
The central bank has committed to moving “expeditiously” to a neutral setting — one that neither stimulates nor slows down growth — although Fed chair Jay Powell recently conceded that that threshold is “not something we can identify with any precision”. Rather, he vowed to keep pressing ahead until there is “clear and convincing” evidence that inflation is moderating.
The central bankers will convey their forecasted policy path in an updated “dot plot” to be released on Wednesday, which maps out individual interest rate projections as part of a broader set of estimates about the economic outlook. In its most recent set of projections, published in March, top officials pencilled in a benchmark policy rate of 1.9 per cent by year-end, and 2.8 per cent in 2023.
Policymakers are also due to publish updated forecasts for inflation, growth and unemployment, which are expected to reflect Powell’s recent admission that the moves needed to tame price pressures will lead to “some pain”.
Economists had taken issue with March’s estimates, which suggested little movement in the unemployment rate from historically low levels even while policy became significantly tighter.
Powell has since acknowledged that the unemployment rate is likely to move up “a few ticks” and that the central bank may only be able to achieve a “softish” landing for the economy — a message Gargi Chaudhuri, head of iShares investment strategy for the Americas at BlackRock, chalked up to: “We can’t go all guns blazing now without some spillover.”
The median unemployment rate forecast is expected to reach about 3.8 per cent by 2024, 0.2 percentage points higher than its current level, while officials are likely to peg inflation closer to 5 per cent this year.
A more substantive slowdown in gross domestic product growth is also anticipated. That in turn has increased the odds that some policymakers will predict outright rate cuts in 2024, reflecting the belief that the economy will have slowed notably by then.
A recent poll of leading academic economists by the Financial Times showed nearly 70 per cent believe the US economy will tip into a recession next year.
Priya Misra, head of global rates strategy at TD Securities, said the Fed is now grappling with a much more difficult problem than just a few months ago. “They have two-sided risks now with growth and inflation,” she said.
For Stephanie Aaronson, another former Fed staffer now at the Brookings Institution, the central bank will need substantial luck to avoid a hard landing.
“If they don’t get much help on the supply side in terms of relief on energy and food prices . . . and they really have to do a lot more of the work on bringing down inflation themselves, they would not be able to do that with a soft landing.”