US Fed keeps door open on rate hike

The central bank has held rates steady at a 22-year high as it sorts through the implications of unexpectedly strong growth and higher borrowing costs.

The Federal Reserve left interest rates unchanged at a 22-year high and signalled rates would remain elevated well into next year to keep inflation moving down.

“The committee is proceeding carefully,” Fed chair Jerome Powell said on Wednesday during a press conference where he danced around questions over whether the central bank was leaning toward raising rates at its December policy meeting.

Officials have been trying to balance two risks. They don’t want to overdo rate rises to avoid causing an unnecessarily severe downturn. They also don’t want to allow inflation to re-accelerate or to settle at levels well above their 2 per cent target.

“We’re getting to a place where the risks are closer to being in balance,” Powell said.

The Fed’s decision comes at a delicate time for financial markets because the 10-year Treasury yield has risen swiftly – by nearly 1 percentage point – since July, when officials last raised rates. They lifted their benchmark federal-funds rate then to a range between 5.25 per cent and 5.5 per cent.

Officials described recent economic activity as strong and highlighted how a run-up in long-term interest rates could weigh on economic activity, according to a statement after their two-day meeting.

They have now skipped a rate hike for two consecutive meetings, making it the longest period without an increase since they began to lift rates from near zero in March 2022. Since then, they raised rates at the fastest pace in four decades to combat high inflation.

The big questions for the Fed centre on what officials are looking to see in the economy, and what it would take for them to conclude they are moving in the right or wrong direction.

A continued slowdown in inflation could allow officials to continue holding rates steady, while any acceleration in price pressures could lead them to hike again.

Since they met in July, the economic outlook has been buffeted by three forces that have differing implications for policy.

First, economic activity picked up, defying expectations of an imminent slowdown. Consumers boosted their spending briskly and employers rapidly expanded payrolls, assisted in part by a recovery in the share of people looking for work.

Second, inflation continued cooling. Core inflation, which excludes volatile food and energy prices and which peaked at 5.6 per cent last year, hit a 2.8 per cent annualised rate over the April-to-September period, according to the Commerce Department.

Third, financial conditions have tightened amid a swift run-up in longer-dated Treasury yields, leading borrowing costs to rise for households and businesses. Increases in longer-term interest rates boost costs for mortgages, auto loans and business debt, all of which could slow economic growth. The 30-year fixed-rate mortgage has hovered closer to 8 per cent in recent weeks at 23-year highs, for example, which is chilling demand for home purchases.

The degree to which higher borrowing costs slow the economy depends on why they are rising. Yields can rise because investors expect the Fed will have to raise short-term interest rates more to slow inflation or because they expect inflation to rise. Both were the case over the past two years.

If higher yields are tightening financial conditions because investors expect the Fed will have to raise rates higher, officials would have to follow through or risk an easing in financial conditions that makes it harder to bring down inflation.

But if yields are rising because demand for longer-dated securities is weakening at a time of higher supply to finance growing federal budget deficits, that would suggest the extra yield – or “term premium” – that investors demand for the risk of buying longer-dated securities is rising. Higher term premiums could accomplish the same goals as Fed rate hikes by slowing the economy.

Stronger growth, if sustained, could raise anxieties inside the central bank.

That is because the economy has proven remarkably resilient so far to rapid rate increases, the run-off of the Fed’s $US8 trillion asset portfolio and banking stresses that flared with the sudden collapse of three midsize banks this spring.

Some former Fed officials say there is little reason for the central bank to keep hiking rates as long as inflation and wage growth continue to slow gradually.

In that case, “I don’t see a reason to make policy more restrictive,” said Eric Rosengren, former Boston Fed president.

But others think the central bank should err on the side of raising rates next month as insurance against the risk that growth and inflation prove more resilient to the Fed’s tightening. “I lean in the direction that they are going to get this hike in,” said Richard Clarida, former Fed vice chair.

It is in the Fed’s interest to keep a possible rate hike on the table “because the minute they completely rule that out, the next question is going to be, ‘When are the rate cuts coming?’” said Dean Maki, chief economist at hedge fund Point72 Asset Management.

“The committee is not thinking about rate cuts at all, not talking about rate cuts,” Powell said at his post-meeting press conference.“ We will keep policy restrictive until we are confident that inflation is on a sustainable path down to 2 per cent,” Powell added.

– The Wall Street Journal