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Fed officials prepare to extend rate pause without saying hikes are done

Bloomberg
Bloomberg • 5 min read
Fed officials prepare to extend rate pause without saying hikes are done
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Federal Reserve officials look set to hold interest rates steady for the second time in a row next month — but they’re far from calling an end to their tightening campaign.

Policymakers across the hawk-dove spectrum have signaled in recent days that they’re inclined to forgo a rate hike at their Oct 31-Nov. 1 meeting following a run-up in bond yields that has tightened financial conditions. 

But with data on the labor market and inflation showing an economy that’s still humming, the Federal Open Market Committee is unlikely to take further rate increases off the table.

“It’s too soon to declare victory,” Minneapolis Fed President Neel Kashkari, who has a rotating vote on rates this year, said Tuesday during a town hall event in North Dakota.

Minutes from the Fed’s September gathering released Wednesday showed policymakers see a slew of risks that could push inflation higher than they expect, including shocks to food prices, a stronger housing market and a slowdown in the decline of goods prices. An anticipated ground war between Israel and Hamas also threatens to keep energy prices elevated, which could feed into more inflation pressures. 

Recent economic data also highlighted a resilient economy despite the Fed raising rates more than five percentage points since March 2022.

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US Inflation Is Still Running at a Brisk Pace | So-called supercore measure of consumer prices rises by most in year

Hiring surged last month as employers added 336,000 jobs — double the number estimated by economists, and the most since the start of the year. Producer prices rose more than forecast, and core inflation excluding shelter and energy services — a measure closely watched by Chair Jerome Powell — also picked up.

See also: Fed signals one rate cut this year, but keeps door open to two

The repeated “head fakes” in the economic data will make policymakers wary of signaling an end to further tightening, said Priya Misra, a portfolio manager at JP Morgan Investment Management in New York.

“Whenever they are done, I don’t think they will say they are done,” Misra said. “They will want to keep the expectation or optionality to hike.”

Fed officials are increasingly focused on trying to balance the risk of overshooting — and triggering a possible recession — against the need to get inflation back to target. They’re also wary of making the same mistake as the Bank of Canada, which in June had to restart its rate-increase campaign after a conditional pause, citing “excess demand” that was more persistent than anticipated. 

San Francisco Fed President Mary Daly called it the hardest phase of policymaking, as officials try to communicate how they are straddling two-sided risks.

“When you don’t know exactly what will be needed, it’s not actually a terrific idea to telegraph one thing or the other,” she said on Oct. 5. “We could find ourselves with data that are really accelerating, and I don’t want to be in a position where we’ve said definitively we’re not going to do X, and then X is needed.”

Yield Surge
Nevertheless, a fast rise in bond yields after the Sept. 19-20 policy meeting has led some officials to conclude that they can skip a hike for the second consecutive meeting as higher market rates are doing some of the work of restraint.

Philip Jefferson, who as vice chair plays a key role in communicating Fed policy on behalf of Powell, said Monday he’s watching the increase in Treasury yields as a potential further brake on the economy.

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“Looking ahead, I will remain cognizant of the tightening in financial conditions through higher bond yields and will keep that in mind as I assess the future path of policy,” he said.

Yields on the US government 10-year note touched the highest levels since 2007 on Oct. 6 before closing at 4.8%. As Fed officials signaled a November hike might be off the table, yields fell back, closing the week at 4.61%.

“We’re in this position where we kind of watch and see what happens,” Fed Governor Christopher Waller said Wednesday at a conference in Park City, Utah.

Others, including Philadelphia Fed President Patrick Harker and Atlanta Fed chief Raphael Bostic, have gone further, saying policy is restrictive enough to guide inflation back to the central bank’s 2% goal.

But such a clear signal is unlikely to come from the Fed’s policy committee. 

In projections submitted just last month, 12 of 19 officials said they expect another rate increase before the end of the year.

While policymakers could at some point tweak their post-meeting statement — which referenced “the extent of additional policy firming” — the data haven’t yet indicated that the inflation battle is over.

The last reading on the Fed’s preferred core inflation measure showed prices rose 3.9% in the 12 months through August.

Communication Risks
A strong signal that the rate-hiking cycle is over risks a powerful rally in stock and bond markets, inducing more consumption and growth just when Fed officials are trying to moderate demand.

Households seem to believe that the inflation fight is far from convincingly won. Both short- and longer-run inflation expectations moved higher this month, a University of Michigan survey showed Friday.

“They can’t signal they are done,” said Lou Crandall, chief economist at Wrightson ICAP LLC, because it immediately sets up expectations of when the Fed will start cutting.

Fed officials also see it as essential to keep a lid on inflation expectations, and have repeatedly emphasized their commitment to restoring price stability, even if it means raising rates higher than they currently expect.

“Two percent is and will remain our inflation target,” Powell said in his Aug. 25 remarks at the Jackson Hole, Wyoming, central bank symposium.

The Fed chief is set to speak Thursday at the Economic Club of New York.

Lifting the threat of further hikes could also undermine that credibility with the public, raising the risk that inflation will become entrenched.

“There is a very substantial risk that they will need to do more,” said Andrew Levin, a former senior Fed adviser who’s now a professor at Dartmouth College.

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