Ben Casselman
Investors are giving up on dreams of imminent rate cuts as inflation remains stubborn, a problem that could prod Federal Reserve policymakers to keep borrowing costs high for a longer period.
The latest reading of the Fed’s most closely watched inflation measure, released Friday, showed that price increases remain notably faster than the Fed’s 2% goal.
The personal consumption expenditures index rose 2.7% in March from a year earlier, up from 2.5% in February. And after stripping out volatile food and fuel prices for a clearer reading of price trends, inflation remained steady at 2.8% on an annual basis.
The report was just the latest sign that, after months of steady improvement in 2023, progress on cooling inflation is stalling out in 2024. And that unexpected roadblock has caused policymakers, economists and investors to question how soon and how much the Fed might be able to cut borrowing costs. Fed Chair Jerome Powell signaled last week that central bankers were not seeing the progress that they were hoping to witness before lowering rates.
The Fed meets next week in Washington to discuss its next rate move. While it is widely expected to leave interest rates unchanged in its decision on Wednesday, investors will watch a news conference with Powell closely for hints about how long rates are likely to stay on hold. If inflation remains sticky in the months to come, it could prod officials to keep interest rates at their relatively high level for an extended time as they try to tap the brakes on the economy and snuff out price increases more fully.
“There’s a much greater uncertainty about the disinflationary path,” said Matthew Luzzetti, chief U.S. economist at Deutsche Bank, noting that “you’re continuing to see an economy that’s chugging along quite well.” Policymakers raised interest rates to 5.33% between March 2022 and last summer, and have held them steady since. They think that is high enough to eventually weigh on the economy — in economics parlance, it is “restrictive.” But some economists have begun to question just how restrictive the Fed’s current rate setting is, because growth has remained solid and hiring rapid even after months of relatively high rates.
Data released Friday showed that momentum continued in March: Consumer spending rose 0.8% for the second consecutive month, ahead of forecasters’ expectations. That spending is being supported by a strong market that is pushing up wages: Americans’ after-tax income in March significantly outpaced price increases for the first time since December.
Separate data from a University of Michigan survey on Friday showed that consumers had become slightly more pessimistic in April about the outlook for both the economy as a whole and inflation in particular.
Stock indexes rose Friday, in part because Wall Street had been bracing for a slightly worse inflation report after data released Thursday suggested that price gains might have been hotter in March than the personal consumption expenditure figures showed.
Friday’s figures “could be viewed with a sigh of relief,” Omair Sharif, founder of Inflation Insights, wrote in a note after the report.
Even so, investors see a greater chance of a long period of high rates — which tend to dent stock prices — than they did a month or even just a week ago. Investors are now betting that the Fed might make its first move in September or later, based on market pricing. A small but growing share think the central bank may not manage to cut rates at all this year.
Given the economy’s momentum, some economists are even wondering if Fed officials could begin to contemplate raising rates again.
Michelle Bowman, a Fed’s governor, has already said that while it was not her “base line outlook,” she saw “the risk that at a future meeting we may need to increase the policy rate further.” While markets are likely to fixate on whether rates might increase again, it is more likely that the Fed will simply hold them at a high level for longer, said Blerina Uruci, chief U.S. economist at T. Rowe Price.
It would likely take an outright acceleration in inflation to prod the Fed to lift borrowing costs again, she said, rather than just the stalled progress seen in recent months.
“I don’t think we’re at the point where we need to talk about increasing interest rates this year,” Uruci said. “But we’re certainly at the point where we need to talk about fewer cuts.” Many economists think that inflation is still likely to slow further, in part because cooler new rent prices are still slowly feeding into official inflation data. But the process is taking longer than many had expected, and with the economy so solid, the risk that inflation could remain firm has grown.
Plus, economists have regularly found their predictions for inflation upended by economic surprises in recent years: It was not expected to climb as quickly as it did in 2021 and 2022, and then it fell slightly faster than many had anticipated late last year. Now, its flatlining has been a surprise.
“After the past several years, you have to be humble,” Luzzetti said.
Higher interest rates are meant to rein in inflation by making consumers and businesses more reluctant to spend. That appears to have happened to some degree: High mortgage rates led to a sharp slowdown in the housing market, and businesses have pulled back on capital investments and posted fewer job openings.
But the economy as a whole has proved remarkably resilient to the effects of high borrowing costs. Consumers have been particularly undeterred, opting to draw down savings and rack up credit card debt even as they have complained about high prices. Americans saved just 3.2% of their after-tax income in March, the lowest rate since 2022.
At Portland Gear, a clothing retailer in Portland, Oregon, sales keep setting records as customers snap up $79 sweatshirts and $36 baseball caps, said Marcus Harvey, the company’s founder.
“Consumers might say that things are getting expensive, but their buying habits aren’t really saying that,” he said.
As a result, Harvey is continuing to invest, despite the pinch of high interest rates. The company recently opened a flagship store in downtown Portland and is opening a location in the city’s airport.
“It is what it is: For the next five years, rates are going to be high,” Harvey said. “You just can’t do anything about it. Business goes on. Life goes on.” - The New York Times
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