(Bloomberg) – Federal Reserve policymakers are poised to resume raising interest rates this month and remain open to another hike later in the year.
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While officials were encouraged by an easing in price pressures last month, they are not inclined to declare the end of their battle to contain inflation which has repeatedly surprised them with its persistence. Contributing to their caution: a keen desire to avoid repeating the mistake of the 1970s, when the Fed prematurely abandoned its efforts to contain inflation, only to see price increases reaccelerate to double-digit levels.
“It’s really too early to say that we’ve declared victory over inflation,” San Francisco Federal Reserve Chair Mary Daly told CNBC on July 13.
Investors have increased bets that the widely anticipated quarter-percentage-point hike at the July 25-26 Fed meeting will be the central bank’s last in this cycle of credit crunch. Stock and bond prices soared higher on those expectations last week, with the yield on the two-year Treasury note – a market barometer of Fed intentions – falling to 4.76% from 4.95% July 7.
Driver of the rally: A sharp drop in inflation last month. Consumer prices rose 3% in June from a year earlier, compared to 4% in May, the Labor Ministry reported on July 12. This is the smallest increase in more than 24 months and well below the 9.1% increase seen just a year ago.
This in turn fueled hopes that the central bank could pull off a legendary “soft landing” for the economy – bringing down inflation without plunging the United States into recession.
“You can’t get in the way of the soft landing narrative right now — that narrative is gaining momentum,” said Mohamed El-Erian, chief economic adviser at Allianz SE and Bloomberg Opinion columnist.
Cautious optimism
Fed officials, for their part, are cautious about over-interpreting one-month data, however reassuring. This is especially the case given that they have been fooled by declines in price pressure before only to see them pick up again.
“That’s good news, but one data point doesn’t make a trend,” Fed Governor Christopher Waller told New York University Money Marketeers on July 13. “Inflation briefly slowed in the summer of 2021 before getting worse. I’m going to need to see this improvement hold before I’m convinced that inflation has slowed.
Read more: Waller says the Fed may need two more hikes to contain inflation
The Fed held interest rates steady in June after raising them for 10 consecutive meetings to a range of 5% to 5.25%. Most policymakers at the time expected to raise rates two more times in quarter-point increments by the end of the year, based on projections released after their June meeting.
Ahead of this month’s meeting, various officials reaffirmed that view while emphasizing that the final outcome will depend on how the economy develops.
“I see no reason why the first of these two increases should not occur when we meet later this month,” Waller said. “From there, I’ll have to see how the data comes in.”
Policymakers said they were more comfortable moving forward with another rate hike now, as the dreaded credit crunch has yet to materialize. Many, however – including Fed Chairman Jerome Powell – warned that it was too early to fully declare the green light following the banking turmoil earlier this year.
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“The Fed is almost certain to hike 25 basis points in July, but the favorable CPI report will bolster voices from the FOMC saying the July hike should be the last – matching our benchmark.”
—Anna Wong and Stuart Paul
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It is not just the persistence of inflation that surprises policy makers. It has also been the resilience of the economy, particularly the labor market, in the face of the Fed’s most aggressive credit crunch in decades.
Powell has repeatedly said that some easing in the labor market will likely be needed to bring inflation back to the Fed’s 2% target.
There are signs happening. Payroll growth slowed to 209,000 last month – the smallest advance since the end of 2020, but still more than double the pace of around 100,000 which Powell said would be perfect for the long-term economy. term.
Wage growth has also moderated, but it also remains above levels Fed officials say is consistent with the 2% inflation target. Average hourly earnings rose 4.4% in June from a year earlier, from a peak of 8.1% in April 2020, shortly after the start of the pandemic, but above average 3.3% that prevailed in 2019.
This has led Powell and other policymakers to judge that there is a greater danger that the Fed will not do enough to contain inflation than it will do too much and trigger a deep recession – though they also said those risks are more balanced now after several rate hikes.
“We are closer to the end of our tightening phase than the beginning,” Cleveland Fed Chair Loretta Mester said in a July 10 speech. “That said, the economy has shown more underlying strength than expected earlier this year, and inflation has remained stubbornly high.”
As a result, “the funds rate will have to rise a bit more from its current level,” she said.
–With help from Steve Matthews and Catarina Saraiva.
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