Fed Set to Raise Interest Rates to 16-Year High and Debate a Pause
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Federal Reserve officials are on track to increase interest rates again at their meeting this week while deliberating whether that will be enough to then pause the fastest rate-raising cycle in 40 years.

“We are much closer to the end of the tightening journey than the beginning,” Cleveland Fed President Loretta Mester said April 20.

Just how much closer the Fed is to that endgame will be a focus of internal debate because officials think their communications around future policy actions can be as significant as individual rate changes.

Officials are likely to keep their options open as they finesse carefully calibrated signals in their postmeeting statement and remarks by Fed Chair Jerome Powell at a news conference after the meeting ends Wednesday.

Another quarter-percentage point increase would lift the benchmark federal-funds rate to a 16-year high. The Fed began raising rates from near zero in March 2022.

Fed officials increased rates by a quarter point on March 22 to a range between 4.75% and 5%. That increase occurred with officials just beginning to grapple with the potential fallout of two midsize bank failures in March.

The sale of First Republic Bank to JPMorgan Chase & Co. by the Federal Deposit Insurance Corp. announced early Monday is the latest reminder of how banking stress is clouding the economic outlook.

Fed officials are likely to keep an eye on how investors react to that deal ahead of Wednesday’s decision, just as they did before their rate increase six weeks ago when Swiss authorities merged investment banks UBS Group AG and Credit Suisse Group AG.

While analysts believe Monday’s deal may further resolve potential banking strains, officials could have to rethink a planned increase if severe and unanticipated financial stresses emerge before their meeting.

The Fed fights inflation by slowing the economy through higher rates, which causes tighter financial conditions such as higher borrowing costs, lower stock prices, and a stronger dollar, which curb demand. 

Until now, officials have been looking for clear signs of a slowdown and easing inflation to justify an end to rate increases. 

But after this week, the Fed’s calculations could flip. Officials could need to see signs of stronger-than-expected growth, hiring, and inflation to continue raising rates.

The economy has shown some signs of cooling, including more muted consumer spending and factory activity. But steady hiring and brisk wage gains could sustain elevated inflation. 

In projections released after their March meeting, a majority of Fed officials thought the central bank would need to make one last quarter-point rate increase before moving to the sidelines. By following through this week, those officials might conclude they have achieved a sufficiently restrictive setting.

Some already have said they want to see how the economy unfolds through the summer before determining whether additional increases are likely.

“I don’t see why we would just continue to go up, up, up, and then go, ‘Oops.’ And then go down, down, down very quickly,” Philadelphia Fed President Patrick Harker said in a presentation April 11. He said he has long expected the Fed would need to raise rates to just over 5%.

So far, officials have little evidence that the March banking turmoil led to a significant pullback in lending affecting economic activity. Results of the Fed’s senior loan-officer survey—a quarterly report on bank-ending trends—will be available to policymakers when they meet this week, even though it won’t be released publicly until after the central bank’s meeting.

Officials who are more concerned about the impact from any tightening of credit conditions are likely to push for a signal that the Fed will suspend rate increases. 

The Fed shouldn’t give up on fighting inflation, “but we also have to recognize that this combination could hit some sectors or regions in a way that looks different than if monetary policy was acting on its own,” Chicago Fed President Austan Goolsbee said April 11. 

Eric Rosengren, Boston Fed president from 2007 to 2021, said last week that if he was still a policy maker he would vote against lifting rates at this meeting. He thinks banking stress is going to be more damaging to the economy than most Fed officials do, he said at an event hosted by Harvard Business School.

At the same time, a sizable minority of Fed officials in March indicated they thought more than one increase would be justified this year if the economic outlook didn’t deteriorate. 

Those officials are more concerned that the central bank will take its foot off the brake too soon and find that inflation, hiring, and economic growth defy forecasts of a steady slowdown this year.

“I would welcome signs of moderating demand, but until they appear and I see inflation moving meaningfully and persistently down toward our 2% target, I believe there is still work to do,” Fed governor Christopher Waller said in an April speech.

While many economists have been focused on a potential recession, the bigger worry for the Fed continues to be an economy that is growing too fast, said Ray Farris, chief economist at Credit Suisse. “In their heart of hearts, they wouldn’t mind some real economic weakness,” he said.

The upshot is that the Fed’s policy statement, which is subject to a committee vote, could be the most important and heavily negotiated step taken by officials this week. At a minimum, the central bank is likely to maintain a bias toward raising rates as opposed to signaling a firm pause, as the Bank of Canada did in January when it made its last rate increase.

Analysts said they saw little benefit for the Fed to either firmly rule out or to tee up a possible increase in June. Since the beginning of last year, the Fed’s policy statement has carried an element of promising rate increases at each subsequent gathering, using language sometimes called forward guidance.

“At times, you don’t need a lot of forward guidance because it’s a situation where it’s not so clear,” New York Fed President John Williams told reporters April 20.

Fine-tuning the statement language is especially important because officials don’t want to prematurely ease financial conditions by igniting a financial-market rally. 

Already, bond investors anticipate the Fed will cut rates later this year. Central-bank officials, however, have broadly signaled they expect to hold rates steady to provide further restraint on economic activity.

“What investors have done since October is to take anything that’s good news and overreact to it,” said Vincent Reinhart, chief economist at Dreyfus and Mellon. If Fed communications are “too dovish, market participants will take that, run with it and run too far.”

Mr. Reinhart, who advised Fed officials on managing the endgame to rate increases in 2006, thinks they will want to avoid signaling a rate increase in June. “Promising one more tightening and not delivering is a bigger incitement [for markets] to rally,” he said.

If the policy statement is anodyne, investors will parse every word of Mr. Powell’s press conference on Wednesday for more clues. “He’s in a terrible position because he is what is standing between investors and a significant dovish rally that undercuts any policy restraint,” Mr. Reinhart said.