Apr 29, 2024 - Economy

The Fed's big question: Are high interest rates doing their job?

Fed chair Jerome Powell

Fed chair Jerome Powell at his March news conference. Photo: Al Drago/Bloomberg via Getty Images

As the Fed's policy-setting committee gathers for a two-day meeting Tuesday, it is being forced to wrestle with an uncomfortable question: Is its interest rate policy really doing as much work as the Fed itself has assumed?

Why it matters: The evidence that the Fed's target rate is restricting economic activity enough to bring inflation down to its 2% target is considerably more muddled than it was a few months ago.

  • That is taking imminent interest rate cuts off the table and has made the timing of their eventual arrival uncertain. It means rising odds that the Fed's next move will be a rate hike, not a rate cut, though Fed officials have stressed that's not what they anticipate.

Driving the news: The Federal Open Market Committee is expected to leave its target interest rate unchanged in a range of 5.25% to 5.5% following the meeting Wednesday afternoon. There will be no new release of economic projections at this meeting.

  • The Fed could announce plans to slow the rate at which it shrinks its balance sheet, known as "quantitative tightening."
  • But the real news will be in what chair Jerome Powell says in a news conference scheduled for 2:30pm ET Wednesday.

State of play: Powell and other Fed officials have expressed great certainty that their current interest rate policy — in place since last July — is restrictive, meaning it is putting the brakes on economic activity in a way that will bring inflation down over time.

  • Yet the labor market remains robust, as does consumer demand. And inflation picked up in the first three months of 2024.
  • Despite a shaky April, financial markets have been buoyant, with the S&P 500 index up 23% since late October and corporate lending abundant.
  • This easing of financial conditions would be expected to stimulate activity, not slow it.

What they're saying: "Powell is likely to continue to refer to the Fed's stance as restrictive" at this week's meeting, write Deutsche Bank economists in a note.

  • "That said, we suspect there may be growing discomfort with this view from officials, particularly given a significant easing of financial conditions in recent months."

Between the lines: Powell is likely to face media questions about the possibility of rate hikes.

  • That's effectively a question about the degree of confidence the FOMC has that its policy is restrictive enough to get the job done on inflation.

The bottom line: Pay careful attention to how he answers questions along those lines — it will be a sign of how much rethinking is going on among insiders about what has been their core assumption for the last year.

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