Three per cent looks like the new normal for US interest rates after this week’s Fed meeting with its new forecasts and the updated dot plot.
This means that anyone hoping for US rates to return to a sub 2 per cent level is silly, and the most likely range will be between 2 per cent and just over 3 per cent, depending on the health of the economy, with the 2 per cent level used for when there’s a big slump in activity.
Right now, with the Fed upgrading its forecasts for growth, jobs and lifting its inflation estimates, 3 per cent is not a target, just a future hope, once inflation dies.
Even though the dot plot showed three rate cuts this year were possible, 2025 and 2026 might see one less in each year than in the December plot as the markets come to agree with the idea that rates will be higher for longer.
Wall Street’s strong bounce on Thursday confirmed that rates will remain higher than the markets had been expecting a week ago.
The latest plot shows that 9 out of 19 officials are now indicating a policy rate above the 4.6 per cent median forecast for 2024 (the current rate is 5.25 per cent to 5.5 per cent).
It also showed that none of the members of the Open Market Committee see rates falling below 3 per cent by the end of 2026 — which these days is close to “long term” as you can get.
It will all depend on the monthly readings for inflation — headline and core readings, especially for the CPI and the Fed’s favoured PCE measure — which is back in focus this week.
Jay Powell made it clear the Fed wants to continue rate cutting — not to help what is a solidly performing economy, but more of an encouragement for sectors doing it tough.
But if inflation continues to repeat the higher than forecast outcomes we saw in January and February then the mooted rate cuts will slowly vanish the longer inflation remains around 3 per cent or a little less.
But Powell knows that with the economy growing at a healthy pace (and the Fed upgrading its GDP forecast to 2.1 per cent for this year from 1.4 per cent last December) and unemployment below 4 per cent, the Fed can take a more measured approach when loosening monetary policy.
“Overall, though, the FOMC (Federal Open Market Committee) has stuck to its view that the underlying inflation picture is improving, notwithstanding the disappointing numbers in the past two months,” Ian Shepherdson chairman and chief economist at Pantheon Macroeconomics said in a note. “In other words, they view the most recent numbers as a temporary interruption rather than a change in the trend.”
Mohamed El-Erian, Allianz chief economic advisor, said the Fed appears to be showing significant patience in two ways.
First in the timeline to reach its 2 per cent inflation target, “indicating a willingness to tolerate higher inflation for longer,” and also in the timeline to reach its target balance sheet size, demonstrated by the Fed’s openness to slow the amount of quantitative tightening in the months ahead, he said.
“The first aspect of patience aligns with the goal of maintaining economic well-being, while the second reflects a desire to prevent liquidity-related disruptions in market functioning,” he explained.
“The economy is strong, inflation has come way down,” Powell said, “and that gives us the ability to approach this question carefully and feel more confident that inflation is moving down sustainably at 2 per cent when we take that step to begin dialling back our restrictive policy.”
2 per cent is the target for inflation, 3 per cent for the Federal Funds rate for the next three years.
==========
Federal Reserve Chair Jerome Powell will continue to seek confirmation inflation is moving closer to the central bank’s 2 per cent target, even after a recent spate of hotter inflation readings.
Powell noted that inflation has cooled considerably from its peak. But, he added, “inflation is still too high, ongoing progress in bringing it down is not assured and the path forward is uncertain.”
“The risks are really two-sided here,” Powell said. “We’re in a situation where if we ease too much or too soon, we could see inflation come back. And if we ease too late, we could see unnecessary harm to employment.”
“The other thing is, in the second half of the year, you had some pretty low readings, so it might be harder to make that 12 month window forward,” Powell said.
“Nonetheless, we’re looking for data that confirm the low readings that we had last year,” Powell continued. “And give us a higher degree of confidence that what we saw was really inflation moving sustainably down to 2 per cent.”
Continued strength in the labor market wouldn’t be a reason to hold off lowering interest rates, said Federal Reserve Chair Jerome Powell.
“Strong hiring in and of itself would not be a reason to hold off on rate cuts,” he said, adding that the job market by itself is not cause for concern around inflation. Earlier, Powell said “an unexpected weakening in the labor market could also warrant a policy response.”
Major inflationary data points — the consumer price index and personal consumption expenditure — rose for both January and February. Fed Chair Jerome Powell thinks this data is just further proof of inflation’s nonlinear path downwards.
“I think they haven’t really changed the overall story, which is that of inflation moving down gradually on a sometimes bumpy road toward 2 per cent,” he said during a press conference on Wednesday afternoon. “We’re not going to overreact to these two months of data, nor are we going to ignore them.
Federal Reserve Board Chairman Jerome Powell reiterated on Wednesday that policymakers still intend to cut rates before the end of this year, assuming economic growth continues.
“We believe that our policy rate is likely at its peak for this type of cycle, and that if the economy evolves broadly as expected, it will likely be appropriate to begin dialling back policy restraint at some point this year,” Powell said.
He also reiterated his confidence in the Fed’s target inflation rate of 2 per cent.