New Fed News Agency: The Fed faces the question of "if" rather than "when" to cut interest rates

Nick Timiraos, known as the "Fed's mouthpiece," said that Fed officials seemed to have it easy at the beginning of the year, but now things have changed. The Fed now has to consider the question of "whether" to cut interest rates, not the question of "when". Here are his views after the release of US CPI data on Wednesday:

The Federal Reserve released another stronger-than-expected inflation report on Wednesday, dealing a major setback to the central bank's hopes of cutting interest rates to boost prospects for a so-called soft landing.

Strong U.S. employment and the likelihood that inflation will stabilize closer to 3% -- rather than the Fed’s 2% target -- could cast doubt on whether the Fed will be able to cut interest rates later this year without further signs of a slowdown in the economy.

The third straight month of above-expected CPI data could put Federal Reserve officials back into an uneasy waiting mode, awaiting either better inflation data or clear signs of economic weakness.

“This will undoubtedly undermine the Fed’s confidence that inflation will return to its 2% target,” said Alan Detmeister, an economist at UBS and former head of the Fed’s inflation forecasting department.

Is it just a bump, or is it stagnant?

Officials including Powell began the year with what looked like smooth sailing: Inflation slowed faster in late 2023 than most economists inside and outside the Fed expected, especially given unexpectedly strong hiring and economic growth in the U.S. The temporary slowdown in inflation gave reason to think that, contrary to conventional wisdom, the final mile in the inflation fight would not be difficult.

The latest data raises two different possibilities. One is that US inflation will continue to fall, but the process will be uneven and "bumpy", but the bumps will be greater. In this case, it is still possible to implement a delayed and slow pace of interest rate cuts this year.

The second possibility is that U.S. inflation is not on a "bumpy" path to the 2% target, but has stalled near 3%. Without clear evidence that the economy is slowing significantly, the Fed's case for cutting interest rates may be entirely defeated.

“Underlying inflation is indeed coming down, and we’ve made progress against inflation, and frankly we’ve made more progress than I would have expected a year ago,” said Jason Furman, an economist at Harvard University. “But we’re not making as much progress as people would have expected three months ago.”

'Just being extra cautious'

Powell told lawmakers in March that Fed officials were “not far” from having the confidence they need to cut rates by mid-year. It might take just one or two tame inflation data points for officials to decide the time is right.

“We don’t want to be in a situation where the good inflation data we had over the last six months turned out to be not an accurate reflection of the true state of underlying inflation, so we are being extra cautious now,” Powell said.

Fed officials often stress that their policy decisions are driven by overall economic data, not just one single piece of data. Yet recent inflation data have more weight than ever as Powell and his colleagues search for a plausible basis to start cutting interest rates as the economy shows signs of solidifying.

The problem of “threading the needle”

When adjusting its interest rate policy, the Federal Reserve needs to balance economic growth and inflation control, which is often likened to "threading the needle" in monetary policy.

The U.S. CPI data for March itself was nothing special. Excluding the volatile food and energy items, the CPI rose almost exactly the same as the 0.4% increase in February.

But with both January and February CPI data stronger than expected, the series of deviations is starting to raise more puzzling questions, including whether the conventional wisdom about inflation is wrong again: if the Fed fails to deliver any rate cuts this year, or if investors are too confident that the Fed will deliver a soft landing.

“It is dangerously complacent for investors to assume that the Fed can successfully solve this problem,” said Peter Berezin, chief global strategist at BCA Research. “The market has priced in a soft landing, but if there is a second wave of inflation or a recession caused by rising unemployment, the market will sell off its holdings significantly.”

Futures contracts tied to the federal funds rate show traders are pricing in rates around 5% by year-end, implying just one or two quarter-point rate cuts this year, according to FactSet data. At the start of the year, traders had been expecting six or seven rate cuts from the Fed.

Many Wall Street forecasters on Wednesday abandoned their forecasts for a June rate cut and three more this year. Economists at Goldman Sachs and UBS now expect the Fed to start with two rate cuts, in July and September, respectively. Analysts at Barclays expect a single rate cut in September.

"The June rate cut was a key support for our forecast of three Fed rate cuts this year. If that expectation is not met, we think the first rate cut could easily be delayed to December," said Blake Gwinn, interest rate strategist at RBC Capital Markets.

The article is forwarded from: Jinshi Data