The Federal Reserve’s decision to hold its key interest rate between a range of 5.25% and 5.5% might not have pleased anyone—and that’s kind of the point.
The Fed was widely expected to stand pat today, and it did. Investors also were watching to see whether Fed chair Jay Powell would hint at the central bank’s outlook on a potential rate hike at its December meeting. He insisted the decision will be based on data—two more inflation readings, two more labor market readings—and not prejudged.
“This has been a resilient economy, it’s been surprising in its resilience,” Powell told reporters after the Federal Open Market Committee finished its November meeting.
The big question for markets and citizens remains the same: How soon will the Fed be prepared to cut rates? You’ll be shocked to hear that some economists think the economy is still too hot and liable to see prices increase too quickly, while others fret that the Fed is in danger of overshooting and plunging the economy into a deep recession.
Powell says he and his colleagues haven’t even gotten to the question of cuts yet; he still isn’t sure whether monetary policy is tight enough to keep driving inflation downward. The Fed’s answer is to wait and watch, but there are still dangers in the monetary policy board’s apparent plans to keep interest rates where they are for longer.
The economy is sending mixed signals, although perhaps less mixed than in recent months. On the plus side: Third-quarter GDP growth shot through the roof at a 4.9% annualized rate, and the job market remains robust, while inflation continues to trend lower despite slight boosts in recent reports. The Fed’s preferred inflation index, based on government analysis of household spending, rose 3.4% year-over-year in September. That’s higher than the Fed’s 2% target, but far less than the 6.5% increase in prices seen in September 2022.
What about the other data, particularly sentiment and survey data that asks businesses and consumers about their views and plans? Those figures have diverged from the actual economic indicators—perhaps a sign that non-economic grumbles are leaking into questions about finances—but even consumer sentiment as measured by the University of Michigan is starting to turn around.
Without a recession, the US economy is nearly in uncharted territory
Much-mocked recession predictions from economists like Harvard’s Larry Summers relied on historical data. In one 2022 working paper, Summers cited 11 historical instances where average wage inflation was 5% and the unemployment rate was below 5%—each time, there was a recession within two years. He also cited eight instances where average wage inflation was above 5% and unemployment was below 4%—again, each time there was a recession within two years.
The US economy tripped the first wire in the fourth quarter of 2021, and the second in the first quarter of 2022. That means if the US makes it through March 2024 without a recession, we’ll be in uncharted territory. The Atlanta Fed’s GDPNow forecast suggests we might make it at least part way, predicting 1.2% real growth in the last quarter of this year. The specter of growth petering out before the Fed cuts rates is still hovering over all of this, though Powell said today that the central bank’s staff isn’t forecasting a recession.
The presumption behind these recession predictions is that to fight inflation, the Fed would have to raise interest rates high enough to cause a recession. Instead, the economy has been robust even with higher interest rates and inflation has fallen without too much pain for the average American, at least thus far. That might suggest that supply problems related to the pandemic had a big role to play in high inflation; indeed, for the first time in 35 months, US manufacturers are no longer reporting shortages of silicon chips.
The Fed’s interest rate increases have not been without impact
Though the Fed has yet to truly diminish demand in the US, the effects of higher interest rates are starting to crimp investment. That’s notable in the housing market, where 30-year mortgage rates above 7% have slowed new homes under construction, but also in all kinds of businesses that depend on credit, particularly in large green energy projects like building wind turbines. High interest rates also are weighing on the US government, which is assuming a much larger burden to borrow at a time when deficits are unusually high.
Bond markets have watched all this with caution. Last week’s hot GDP print brought a sell-off of US government debt, leading to a burst of higher yields for longer term US bonds. That could finally end the “yield curve inversion”—the fact that it costs the US government less to borrow money for 10 years than it does for just a month.
That could be interpreted in several ways: Powell says it’s not clear yet if this trend is persistent or just run-of-the-mill market volatility. Bill Gross, the erstwhile Bond King, is expecting a recession before the end of the year and is betting that the Fed will cut rates, making those cheap bonds more valuable. It could simply be a sign of slowing demand for Treasurys, as the US sells more debt and the Fed buys less of it. It might actually be the markets doing the Fed’s job for it, since higher yields mean tighter credit across the economy, and returning the yield curve to its normal slope.
That gets at the Powell’s challenge in these unusual times. The central bank was late to start to reigning in the bucking bronco of the US economy when it started hiking in 2022. But after several years of tightening its hold, it’s not clear whether hanging on or letting go is the safer option.