From Wall Street traders to car dealers to home buyers, Americans are eagerly anticipating the Federal Reserve to commence cutting interest rates to alleviate the burden on borrowers. The Fed is expected to do so this year — possibly multiple times. Inflation, as measured by its preferred gauge, increased in the second half of 2023 at an annual rate of about 2% — the target set by the Fed. Yet, this week, several central bank officials emphasized that they weren’t ready to take action just yet.
Most of the Fed’s policymakers have expressed optimism that despite the ongoing growth of the economy and job market, inflation pressures will continue to diminish. However, they also warn that the strong economy poses a real risk of reigniting price increases.
Several officials have indicated a preference for additional time to observe if inflation continues to decrease. Furthermore, they note that the robust economy is able to thrive without any rate cuts.
Steven Blitz, chief US economist at GlobalData TS Lombard, believes that the Fed will take a cautious and gradual approach, willing to wait and see. The enduring strength of the economy has prompted discussions on the effectiveness of the Fed’s 11 rate hikes. If significantly higher borrowing rates only marginally restrain the economy, some officials may argue in favor of maintaining high rates for a longer period or requiring very few rate cuts.
The economy’s sustained resilience grants them the luxury of adopting a prudent strategy. For example, in January, American employers hired 353,000 workers, and the unemployment rate remained at 3.7%, just above a half-century low.
Loretta Mester, president of Federal Reserve Bank of Cleveland, expressed a lack of urgency, indicating a possibility to lower the rate later in the year, provided that the situation unfolds as anticipated. However, this cautious approach poses risks. Prolonged high borrowing rates may lead to reduced borrowing and spending, weakening the economy and potentially causing a recession.
High rates also present challenges for banks with troubled commercial real estate loans, as refinancing becomes more difficult. The increased cost of borrowing has affected businesses such as David Kelleher’s Chrysler-Jeep dealership outside Philadelphia, where customers are now facing higher monthly car payments due to elevated interest rates.
Kelleher anticipates that the Fed will reduce its benchmark rate by May or June, aligning with the expectations of most economists. However, economic growth has accelerated since then, with the economy expanding at a robust 3.3% annual rate in the final quarter of last year.
There are concerns that the economy may not be heading for a soft landing but rather staying robust with ongoing inflation pressures. This could lead to the Fed maintaining high rates for an extended period. Fed Chairman Jerome Powell acknowledged the risk of inflation accelerating and highlighted the need to keep options open.
Other officials emphasized the Fed’s balancing act between the risk of cutting rates too soon, potentially causing inflation to re-accelerate, and keeping rates too high for an extended period, which could trigger a recession.
Some analysts have suggested signs of improved productivity in the economy, potentially allowing for faster growth without a significant increase in inflation. Yet, the productivity data is notoriously challenging to measure, and any substantial improvement may not be apparent for years.
Eric Swanson, an economist at the University of California, Irvine, speculated that the economy might be able to withstand higher interest rates than previously thought. This could result in delaying the Fed’s rate cuts and potentially reducing their frequency.
