The Delicate Path Ahead for the Federal Reserve

Inflation has decreased significantly, but the battle is still ongoing, and the Federal Reserve faces a delicate path ahead.

The Next Fed Meeting

As the next Fed meeting approaches in two weeks, all attention is on the members of the central bank's Federal Open Market Committee (FOMC). Together, they will decide whether to continue increasing the short-term interest rate, maintain stability, or consider cutting rates.

A Possible Change at the September Meeting

Dallas Fed President Lorie Logan, a voting member of the FOMC, suggested that skipping rate hikes might be appropriate at the September meeting. However, this doesn't mean that the Fed will permanently halt rate increases. Logan shared this insight while speaking at the Dallas Business Club at Southern Methodist University.

Market Expectations

This aligns with market expectations. According to the CME FedWatch Tool, futures traders have increased the probability of unchanged rates at the September meeting to 93%, up from 86% a month ago. Despite this, there is still around a 40% chance of another 25-basis-point hike at the subsequent November meeting.

A Carefully Calibrated Approach

Logan emphasized that a carefully calibrated approach is required to return inflation to 2%. She stated, "After the unacceptably rapid price increases of the past several years, I'm not yet convinced that we've extinguished excess inflation. But in today's complex economic environment, returning inflation to 2% will require a carefully calibrated approach - not endless buckets of cold water." Logan drew an analogy between tightening monetary policy and putting out campfires.

Previous Rate Increases and Effects

Over the past 18 months, the Federal Reserve has raised short-term fed fund rates 11 times, bringing them to the highest levels in 22 years - ranging between 5.25% and 5.5%. Unsurprisingly, these aggressive moves have had an impact. Inflation has continued to cool down this year, with the annual growth rate of the consumer price index falling to 3% in June, the lowest since March 2021.

The Current Situation: July and Beyond

However, in July, the consumer price index started to pick up again, unemployment remains low, wage growth remains strong, and other indicators suggest that the economy continues to accelerate. These factors have prompted speculation about whether the Fed's current policies are sufficient to return inflation to 2%, or if further action is necessary.

Fed Chair Jerome Powell Indicates Openness to Further Rate Increases

In a speech at the Jackson Hole Economic Symposium in late August, Federal Reserve Chair Jerome Powell stated that the Federal Open Market Committee (FOMC) is ready to raise rates more if necessary. He also emphasized that the committee plans to maintain a "restrictive level" of policy until they are confident that inflation is steadily moving towards the 2% objective.

While Powell's remarks show a willingness to consider further rate hikes, the central bank acknowledges the need for more time and data before making any definitive decisions. New York Fed President John Williams, another FOMC member, echoed this sentiment during a recent speech at the Bloomberg Market Forum, emphasizing the importance of patience.

Williams pointed out that although consumer demand has been strong, much of it is due to fiscal stimulus and accumulated savings during the pandemic. He noted that savings have decreased, fiscal stimulus is diminishing, and the long-term effects of higher interest rates will become more pronounced.

"While we've seen robust consumer spending, there are reasons to believe that it won't remain at this level," said Williams. "The economy may be experiencing acceleration in the third quarter, but this sets an exceptionally high bar for the fourth quarter, which could result in contraction as it becomes unsustainable."

Williams also highlighted the narrowing gap between labor supply and demand, evident in lower job vacancies and quit rates. He emphasized that this inflation cycle differs from previous ones, where reducing unemployment played a significant role in bringing down inflation.

Nevertheless, Williams anticipates a slight increase in the unemployment rate over the next year, surpassing 4%. As of August, it stands at 3.8%. Several economic indicators, such as Consumer Price Index (CPI) readings and retail sales figures, are still scheduled to be released before the September FOMC meeting.

Overall, Powell and Williams' remarks reflect the ongoing evaluation of economic conditions that will guide the Federal Reserve's decisions in the coming months.