Powell pivot: Fed Reserve’s focus now on rate cuts

Rapid US inflation improvement has one of the world’s most important decision-makers, Federal Reserve chair Jerome Powell, changing tack on rates, but ‘no one is declaring victory’.

The Federal Reserve held interest rates steady overnight and signalled inflation had improved more rapidly than anticipated, opening the door to rate cuts next year.

Most officials pencilled in three interest rate cuts for 2024 in projections released after their two-day meeting.

Officials have hesitated to declare mission accomplished and were careful not to rule out higher rates in their policy statement, which was little changed from recent versions that have said tighter policy remains possible.

But another hike seems remote because inflation has declined much faster than officials anticipated this year. In their latest projections, they expected core prices, which exclude volatile food and energy items, to rise 3.2 per cent this quarter from a year ago, down from their September projection of 3.7 per cent. They see core inflation of 2.4 per cent at the end of next year, down from their September expectation of 2.6 per cent.

“No one is declaring victory. That would be premature,” said Fed chair Jerome Powell at a news conference.

Powell allowed that officials were looking ahead to when they might lower rates as inflation slows. “That begins to come into view, and clearly it’s a topic of discussion,” he said.

Wall Street indexes jumped higher during the press conference by Powell with the Dow Jones set for a record close.

What a difference two weeks (and one inflation report) can make.

Two weeks ago, he said it “would be premature to … speculate on when policy might ease.” Overnight, he said rate cuts are something that “begins to come into view” and “clearly is a topic of discussion.”

Fed officials didn’t rule out tighter policy in their statement overnight, but Powell strongly suggested that the focus going forward is on when to cut rates rather than when to increase them.

When it comes to leaving interest rates too high for too long, Powell said, “we know that that’s a risk, and we’re very focused on not making that mistake.”

Fed officials’ latest forecasts show the fed-funds rate will be 4.6 per cent at the end of 2024 – the equivalent of three quarter-point reductions. Traders are betting they’ll cut interest rates to 4 per cent.

Officials began raising rates from near zero in March 2022 and lifted them most recently in July to a range between 5.25 per cent and 5.5 per cent, a 22-year high.

Central-bank officials are trying to balance two risks: One is that they move too slowly to ease policy and the economy finally crumples under the weight of higher interest rates, causing millions of people to lose their jobs.

The other is that they ease prematurely and inflation settles above 3 per cent – higher than their 2 per cent goal.

The US economic outlook has brightened in recent months because inflation and wage growth are slowing. That would give the Fed more room to lower rates rapidly if the economy weakens more than officials expect, and it could open the door to cuts even if the expansion doesn’t stall.

Investors were buoyed by Powell’s post-decision commentary. Picture: Angela Weiss/AFP

Government data released this week suggest core prices, which exclude food and energy items, will show a very mild gain for November as measured by the Fed’s preferred inflation gauge when it is released later this month. That could put the six-month annualised inflation rate at or slightly below the Fed’s 2 per cent target.

Meanwhile, the labour market has been cooling but remains solid.

The unemployment rate ticked down to 3.7 per cent last month from 3.9 per cent in October.

One year ago, many economists anticipated that Fed officials would have to raise rates to levels that would create enough slack — such as unemployed workers and idled factories — to significantly slow inflation.

But healed supply chains and an influx of workers into the labour force are curbing wage and price increases without causing broad economic weakness.

The reasons why officials lower rates matter. Often, the central bank trims rates to shore up a deteriorating economy and job market. Indeed, this forms the basis for several analysts’ forecasts of cuts next year.

But Fed officials have acknowledged that they could lower rates next year simply because inflation is well on its way to their 2 per cent target.

Holding rates steady as inflation falls would lead inflation-adjusted or “real” rates to rise, which the Fed doesn’t want. Officials could lower nominal rates simply to prevent real interest rates from turning too tight.

– The Wall Street Journal