Hopes for interest rate cuts this year by the Federal Reserve are gradually diminishing, as recent comments from Fed officials highlight their intention to maintain high borrowing costs as long as necessary to control persistent inflation.
The delay in rate cuts is largely due to inflation pressures that are plaguing the economy, driven primarily by lingering effects of the pandemic – affecting everything from apartment rents to car insurance to hospital prices. Although Fed officials anticipate that inflation in these areas will eventually subside, they’ve indicated their readiness to wait as long as required.
However, the policymakers’ decision to keep their key rate at a peak not seen in two decades – thereby keeping costs painfully high for mortgages, car loans and other forms of consumer borrowing – carries its own risks. The Fed’s mandate is to strike a balance between keeping rates high enough to control inflation yet not so high as to damage the job market.
While most measures show that growth and hiring remain healthy, some indicators of the economy have started to show signs of weakness. The longer the Fed keeps its benchmark rate elevated, the greater the risk of causing a downturn.
Meanwhile, with polls revealing that higher costs for rent, groceries and petrol are infuriating voters as the presidential campaign heats up, Donald Trump has attempted to place the blame for rising prices squarely on President Joe Biden. The Federal Reserve, under the leadership of Chair Jerome Powell, has hiked its benchmark rate by 5 percentage points from March 2022 through June 2023 – marking the quickest such increase in four decades – in an attempt to bring inflation back down to its 2% target.
According to the Fed’s preferred measure, inflation has plummeted from 7.1% in June 2022 to 2.7% in March. However, the same gauge revealed that prices picked up pace in the first three months of 2024, disrupting last year’s steady slowdown. Economists are predicting that this Friday’s government report will show this measure rose 2.7% in April from a year earlier.
A different inflation indicator reported by the government earlier this month suggested that prices slightly cooled off in April. But with inflation persistently above the Fed’s target level, Wall Street traders are now only expecting one rate cut this year, in November.
And even that is far from guaranteed, with investors estimating the likelihood of a November cut at 63%, down from 77% just a week ago. Last week, economists at Goldman Sachs became the latest analysts to abandon hopes for a rate cut in July, pushing their forecast for the first of two expected cuts this year back to September. Oxford Economics made a similar prediction last month.
Bank of America anticipates just one Fed rate cut this year, in December. Just a few months ago, many economists were forecasting the first rate cut for March of this year.
Loretta Mester, president of Federal Reserve Bank of Cleveland and one of the 12 officials voting on the Fed’s rate policy this year, has stated: “We will need to accumulate further data over the coming months to have a clearer picture of the inflation outlook,” adding, “I now believe that it will take longer to reach our 2% goal than I previously thought.”
Meanwhile, there are indications that the economy may be cooling slightly. For instance, an increasing number of Americans, particularly younger adults, are falling behind on their credit card payments.
The proportion of card debt overdue by 90 days or more reached 10.7% in the first quarter, according to the Fed’s New York branch – the highest level in 14 years. The pace of hiring is also slowing down, with fewer job openings being posted, although job advertisements remain high.
Furthermore, several companies, including Target, McDonalds and Burger King, are emphasising price reductions or cheaper deals in an attempt to attract consumers feeling the financial pinch. These actions could contribute to lowering inflation in the upcoming months, but they also highlight the challenges faced by lower-income Americans.
Julia Coronado, a former Fed economist who is now president of MacroPolicy Perspectives, commented: “There’s a lot of signs that consumers are kind of losing some steam and hiring demand is cooling,” adding, “You could see more of a slowdown.”
Economists like Coronado are viewing the latest economic trends as a return to normalcy after a period of explosive growth, noting that companies continue to hire, albeit at a slower rate than earlier in the year. Moreover, record travel over the Memorial Day weekend suggests that Americans feel secure about their financial situation.
Inflation is still running hotter than the Fed’s target, largely due to lingering pandemic-related distortions that keep prices high in certain sectors even as other parts of the economy have stabilized. The surge in housing costs, particularly apartment rents, began two years ago when many sought more living space during the pandemic.
Although the growth in rental costs has deceleratedrising 5.4% in April year-on-year, down from 8.8% the previous yearthey are still climbing at a rate higher than pre-pandemic levels. Last month, significant contributors to the annual increase in “core” inflation, which strips out the unpredictable food and energy sectors, were rent, homeownership, and hotel prices.
Fed officials, including Powell, have admitted that they had anticipated a quicker decline in rental prices. The price for a new lease has nosedived since mid-2022. Government data reveals that the rates for newly leased flats have only increased by 0.4% in the first quarter of 2024, compared to a year earlier.
However, it takes time for these newer, cheaper rents to reflect in the government’s inflation measure. “Market rents adjust more quickly to economic conditions than what landlords charge their existing tenants,” commented Philip Jefferson, the Vice Chair at the Fed and Powell’s top deputy, last week. “This lag highlights that the sharp rise in market rents during the pandemic is still filtering through to existing rents and could keep housing services inflation high for a bit longer.”
Auto insurance costs have skyrocketed nearly 23% from a year earlier, a significant jump that mirrors the spike in new and used car prices during the pandemic. As insurance companies have to pay more to replace totalled vehicles, their customers are consequently charged more. “This is about stuff that happened in 2021,” observed Claudia Sahm, Chief Economist at New Century Advisors and a former Fed economist. “You cannot go back and change that.”
