The Federal Reserve Board building, in Washington, on March 19, 2019.Leah Millis/Reuters
Updated economic projections from Federal Reserve officials this week are expected to show fewer interest rate cuts than policy-makers anticipated three months ago, faster expected inflation, and slower growth, a pinpoint economic outlook that will carry the weight of the U.S. central bank’s authority.
It may also come with what amounts to a consumer warning from Fed Chair Jerome Powell: Actual results may vary.
With their forecasts stymied last year by faster economic growth and lower inflation than expected, and now by higher inflation and slowing growth, Fed officials of late have supplemented discussion of their outlook with the top alternate paths they think the economy may follow.
Both a nod to what they don’t know and a way to keep public expectations more fluid, it’s a strategy Powell may well follow in his news conference after the end of a two-day policy meeting on Wednesday as a way to shift the centre of attention from the new Summary of Economic Projections and its market-shaping plot of where officials think the policy interest rate is heading, with a focus on the median.
“I always emphasize the importance of a story … that ties together in a coherent way the macro outlook and policy strategy,” Larry Meyer, a former Fed governor who now heads consulting firm Monetary Policy Analytics, wrote last week. “The strength of the story … depends on the degree of uncertainty, which has spiked of late. In that case, we should pay more attention to alternative scenarios.”
Since the end of last year, precision has not been the Fed’s ally as officials appeared to lock in three rate cuts for the year, only to be side-swiped by inflation that didn’t decline as expected. As a result, they’ll likely revise their outlook to just two quarter-percentage-point rate reductions for the year or perhaps just one, with doubts even around that.
The U.S. Labor Department on Wednesday will publish new inflation data just hours before the 2 p.m. EDT (1800 GMT) release of the Fed’s updated projections and new policy statement. Powell’s news conference will follow at 2:30 p.m. EDT. The central bank, which aggressively raised rates in 2022 and 2023 to combat a surge in inflation, is widely expected to keep its benchmark interest rate in the 5.25 per cent-5.50 per cent range that was set last July.
Key measures of inflation have barely budged since the last set of projections in March and the April 30-May 1 policy meeting, leaving officials still wary about making an initial rate cut until inflation moves lower. In particular, inflation in the new policy statement is still likely to be described as “elevated,” pushing the rate-hike debate further down the road.
As of April, the personal consumption expenditures price index, which is used to set the Fed’s 2 per cent inflation target, was increasing at a 2.7 per cent annual rate.
Yet unlike the rest of the time since the outbreak of the COVID-19 pandemic in early 2020, the risks now are more nuanced and the data often contradictory. Initially, central bankers were only focused on lowering the unemployment rate after a massive jump in joblessness during the months when many in-person services were shuttered; later the sole focus was on curbing inflation that by mid-2022 had erupted to a 40-year high.
Today, policy-makers are neither fully convinced inflation will return to the 2 per cent target without a longer period of tight monetary policy, nor fully assured that the job market won’t come under stress and slide fast toward higher unemployment.
Data released last week in fact showed one labour market indicator returning to where it was before the pandemic, an encouraging sign of normalization that also put it near what one Fed governor described as a sort of trigger point for rising unemployment.
Fed Governor Christopher Waller has looked closely at the relationship between labour demand and unemployment dynamics, and in a speech in January said his research suggests that if the job openings rate fell below 4.5 per cent “there would be a significant increase in the unemployment rate.”
The rate as of April was 4.8, down from a pandemic peak of 7.4 in March of 2022 and from 5.3 this past February.
“If Waller is correct, then the economy may sooner than expected approach a point where the Fed needs to take the employment mandate into account,” Tim Duy, chief U.S. economist with SGH Macro Advisors, wrote last week, referring to the Fed’s dual congressionally-mandated goals of maintaining stable prices and low unemployment.
Yet hiring and wage growth remain robust. Data released on Friday showed U.S. firms added 272,000 jobs in May, well above the average monthly pace of 183,000 in the decade before the pandemic, with wages rising at a 4.1 per cent annual rate.
After seeing inflation fall quickly last year at little apparent cost to the job market or economic growth, officials have been “trying to wrap their head around” whether further progress in lowering price pressures will require a cooled economy and rising joblessness, Chicago Fed President Austan Goolsbee said in late May.
That would mark a return to one of the more traditional economic trade-offs policy-makers contend with, and also be a sign that some of the excesses of the pandemic – the historic jump in job openings, the trillions in excess cash held by businesses and households, and the tangled global supply chains – had largely disappeared.
But it would also put a broader band of doubt around the Fed’s own projections, and around the timing and pace of any move on interest rates.
The 4 per cent unemployment rate recorded in May, for example, is already where policy-makers at the median expect the U.S. to end the year; yet the ongoing job and wage growth offered clear signs of strength.
Like other recent data, it’s a set of conflicting signals that the Fed will somehow have to either reconcile or deflect.
“The combination of robust payroll job creation, firmer wage growth and weaker labour supply pointed to a labour market that remains tight,” said Lydia Boussour, a senior economist at EY-Parthenon. Yet the rise in the unemployment rate to more than a two-year high “painted a more nuanced picture and corroborated other data pointing to softer labour market conditions.”