Stung by past mistakes, a cautious Fed takes its time

Officials on Wednesday held rates steady and offered little evidence that they were prepared to begin lowering interest rates soon, as their counterparts in Canada and Europe began doing last week.

Most officials projected they could lower rates once or twice in the four remaining meetings this year, suggesting a start to cuts no earlier than September, even after an inflation report that same day suggested pressures on prices moderated last month.

“We’re looking for something that gives us confidence that inflation is coming down sustainably,” Powell said in a news conference in which he used the word “confident” or “confidence” 20 times.

The European Central Bank and the Bank of Canada cut interest rates last week and indicated that further reductions were possible even if inflation remains above their targets, because they expect inflation to continue to decline. “Overall, our confidence in the way forward, because we have to look to the future, has increased in recent months,” ECB President Christine Lagarde said last week.

But the United States is, for now, in a different position. Growth is stronger and tight monetary policy may be transmitting more slowly to the economy. The US financial system is less dependent on bank loans than in the past. Many homeowners are protected from the rapid rate increases in 2022 and 2023 because they locked in ultra-low rates on 30-year fixed-rate mortgages, which are not as common elsewhere.

The Federal Reserve has also focused on monthly inflation readings because the economy, especially inflation, has proven difficult to forecast over the past three years, presenting officials with a possible case of post-traumatic stress disorder.

In 2021, Federal Reserve officials kept rates near zero despite a rise in prices in the view (wrong, in retrospect) that the pressures would be short-lived.

“After an event like that, you will be more worried about your credibility. “You don’t want to make the same mistake twice,” said Jan Hatzius, chief economist at Goldman Sachs.

Market- and survey-based measures of inflation expected in the future by households and businesses suggest that “they have, by all measures, regained their credibility, but they don’t want to take that for granted,” said Julia Coronado, founder of Economic -The advisory firm MacroPolicy Perspectives “They have set a slightly higher bar than other central banks.”

Last year, the Federal Reserve and many private sector economists expected inflation would slow as growth weakened. They were right about slowing inflation, but wrong about growth, which accelerated.

Then, in February and March, just as officials tacitly encouraged expectations that the Federal Reserve could cut rates in the coming months, progress on inflation stalled. “They hit us in the face in the first quarter,” Coronado said.

To be sure, the trust-but-verify approach risks putting the Fed in a dead end. Powell and his colleagues are waiting until they have more convincing evidence that the Federal Reserve’s interest rate setting is as restrictive as they believe. But that raises the risk that it will be too late to prevent a more severe employment decline by the time they see that evidence, a point Powell acknowledged on Wednesday.

“We fully understand that that’s the risk, and that’s not our plan: to wait for things to break down and then try to fix them,” Powell said.

A series of inflation readings that are persuasively benign would free them from this trap. The alternative is for the Federal Reserve to wait to see more economic weakness before initiating rate cuts.

“I think they’re looking for an opportunity to lower the policy rate, but obviously the wind has been blowing in the wrong direction,” said James Bullard, former president of the St. Louis Federal Reserve and now dean of the Daniels School of Business. from Purdue University.

Some Federal Reserve officials have indicated that once they start cutting rates, they plan to do so at regular intervals. In 1995, under Chairman Alan Greenspan, the Federal Reserve took a more idiosyncratic approach: cutting rates once in July and then waiting another five and a half months to cut them again. The Federal Reserve cut rates for the third and final time six weeks later, in January 1996.

Bullard favors a more “Greenspanian” approach that moves away from the idea that the initial move is “very consequential,” he said. “What I would defend is a technical adjustment that takes into account the idea that inflation is lower today than last summer.”

Such a strategy was more like the ECB’s latest move, which followed worse-than-expected inflation numbers and stronger-than-expected growth, Goldman’s Hatzius said.

“However, they have said, ‘Let’s take a small step now.’ “We’re not going to commit to a major easing cycle,'” Hatzius said. “The Federal Reserve could eventually adopt that strategy as well.”

Powell said Wednesday that a decision to cut rates would be “consequential” because it could trigger major market rallies that boost spending and investment. But he downplayed the idea that the exact month in which the Federal Reserve begins cutting rates by a quarter of a percentage point, or 25 basis points, would be equally important.

“If you look back five or 10 years from now and try to highlight what a 25 basis point rate cut means to the U.S. economy, you’d have a big job on your hands,” he said.

Write to Nick Timiraos at [email protected]