The Fed begins to pivot, is a big win waiting?

Federal Reserve officials decided to keep interest rates unchanged at their last policy meeting of 2023 and forecast three more cuts next year, a sign that the US central bank is moving into the next phase of its fight against inflation.

Clear signal

The Federal Open Market Committee (FOMC)’s much-anticipated decision on December 13 left its key interest rate unchanged at 5.25% to 5.5% since July. After a series of rate hikes starting in March 2022 and pushing borrowing costs to a 22-year high this summer, officials have kept monetary policy steady for three consecutive meetings.

That patient stance has given policymakers time to assess whether interest rates are high enough to pressure the economy and ensure that inflation will fall to the Fed's 2% target over time.

Slowing U.S. inflation and a cooling labor market have convinced the Fed it is on the right track. Officials have also said, contrary to previous reports, that they do not expect to raise interest rates further.

In fact, Fed policymakers on December 13 projected borrowing costs to fall to 4.5-4.75 % by the end of 2024. This forecast implies that the Fed will make three rate cuts next year, each by 0.25 percentage points.

World - Fed begins to pivot, is a big victory waiting? — US Federal Reserve Chairman Powell's dovish comments on December 13, 2023, helped fuel the recovery of US stocks and government bonds. Photo: ABC News

Despite sending the clearest signal yet that the US central bank has completed two years of tightening monetary policy and will begin cutting interest rates in 2024, Fed Chairman Jerome Powell still avoided declaring victory over inflation and avoided commenting on the specific timing of rate cuts or what criteria would warrant a rate cut.

In a statement, the Fed outlined conditions under which it would consider “any additional policy consolidation that may be appropriate to bring inflation back to 2 percent over time” – softer language that suggests the US central bank may not see the need to raise interest rates further.

Mr. Powell reiterated that the Fed is committed to proceeding “carefully” in future interest rate decisions with the expectation that economic growth will cool and that there has been “real progress” in pushing back inflation.

Wall Street investors are betting that rate cuts could begin as soon as March, while economists predict borrowing costs will fall from May or June next year.

Regardless, markets cheered the Fed’s optimistic vision of a lower-rate future. The S&P 500 closed up 1.37% on December 13, while the Dow Jones Industrial Average closed at a record high after rising 1.4% – its highest level since January 2022. The 10-year Treasury yield fell to around 4% from 4.21% on December 12.

This time may be different

Americans have been facing rapid inflation since prices began rising rapidly in early 2021. Costs initially soared as global supply chains became clogged and shortages emerged on products including cars and furniture. Inflation was then exacerbated by soaring fuel and food costs following the outbreak of the Russia-Ukraine conflict.

Those big shocks were combined with strong demand: Households saved a lot of money during the pandemic, thanks in part to government bailouts. As they spent enthusiastically, companies had the wherewithal to raise prices without scaring away customers. Companies themselves began paying more to attract workers in a strong labor market with more job openings than available candidates.

That’s where the Fed comes in. The US central bank has been rapidly raising borrowing costs, starting in March of last year – even making a series of huge 0.75 percentage point increases – making mortgages and auto loans more expensive. The goal is to dampen demand and weaken the booming labor market.

In recent months, a combination of supply chain recovery and slightly weaker demand has begun to cause inflation to decline significantly. Data released by the US Bureau of Labor Statistics on December 12 showed that overall consumer price growth slowed to 3.1% in November, down sharply from 9.1% at its peak in June 2022.

The November edition of the Fed's preferred inflation measure, a separate but related and later publication, is scheduled for release on December 22.

World - Fed begins to pivot, is a big victory waiting? (Figure 2). — With US inflation slowing more markedly and the economy and job market cooling, the discussion has shifted from whether the Fed will raise interest rates again to how quickly it will cut rates next year. Photo: PBS News

Fed officials are also pleased to see that the labor market is cooling. Job openings have fallen significantly, and the pace of hiring remains strong but no longer feverish. As the supply and demand for workers balance, wage growth has slowed.

Officials say more modest wage gains could pave the way for slower price increases in services – non-material purchases like haircuts and rent – which have replaced goods as the main driver of inflation.

Historically, efforts to reduce inflation by slowing demand have ended in recession. But officials are increasingly hopeful that this time may be different.

The Fed’s economic projections released on December 13 showed policymakers expect inflation to return to 2% by 2026. They also showed officials still expect the unemployment rate to rise slightly, reaching 4.1% next year, as growth slows but remains positive.

That would be a big win for the Fed, especially considering many forecasters had predicted a recession in late spring and early summer.

Mr. Powell reiterated that he “always” saw a path toward reducing inflation without causing much economic damage, noting that the economy appeared to be making progress toward what economists call a “soft landing” as the job market remains strong and inflation cools.

“Inflation continues to decline, the labor market is gradually returning to balance,” Mr. Powell said on December 13. “So far, things have been very good. Although we think things will get more difficult from here, so far, that has not happened . ”

Minh Duc (According to NY Times, Financial Times)

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