Fed will have to keep rates high for longer than markets anticipate, say economists

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The Federal Reserve will be forced to hold interest rates at a high level for longer than markets and central bankers anticipate, according to academic economists polled by the Financial Times.

More than two-thirds of those surveyed in the FT-Chicago Booth poll think the Fed will make two or fewer cuts this year as it struggles to complete the “last mile” of its battle with inflation. The most popular response for the timing of the first cut was split between July and September.

That is a later start than expected in financial markets, where traders expect three cuts this year, with the first quarter-point reduction coming in June or July. The Fed’s current forecast, which is due to be updated on Wednesday, also sees three cuts in 2024.

The Chicago Booth survey suggests investors may be forced to rein in further bets on easing from the Fed, which is expected to hold rates at the current 23-year high of 5.25 to 5.5 per cent on Wednesday.

“The Fed really wants to cut rates. All of the body language is about cutting. But the data is going to make it harder for them to do it,” said Jason Furman, an economist at Harvard University, who was one of 38 respondents polled this month. “I expect the last mile of inflation to prove quite stubborn.”

If economists are right, that would disappoint the Biden administration, which is keen for borrowing costs to fall to pre-pandemic levels sooner rather than later. This would ease voters’ concerns that mortgages have become unaffordable ahead of November’s presidential vote.

The US president sought to ease the pressure on would-be homeowners through tax credits outlined in this month’s State of the Union address, but that benefit is unlikely to have as big an impact as lowering borrowing costs.

Vincent Reinhart, a former Fed official who is now chief economist at Dreyfus and Mellon, thinks the political calendar will influence rate-setters.

“The data say the best time to cut rates is September, but the politics say June,” said Reinhart, who did not participate in the poll. “You don’t want to start cuts that close to an election.”

Some rate-setters — such as Atlanta Fed president Raphael Bostic — have said they would prefer to make fewer moves than the anticipated three cuts.

Consumer price index and producer price index data both showed higher than expected inflation last week.

CPI inflation for February ticked up to 3.2 per cent, from 3.1 per cent the previous month, while PPI inflation hit 1.6 per cent, up from 1 per cent in January, signalling that most of the post-pandemic fall in the costs of goods had been accounted for.

“The latest numbers show inflation going up, so you don’t want to intervene too fast if you’re a central banker,” said Evi Pappa, professor at the Carlos III University in Madrid. “It’s better to wait for the actual numbers to show inflation has landed close to 2 per cent and then move, rather than relying on projections.”

The data on the jobs market and growth has also been stronger, leading respondents to grow increasingly confident that the US economy will achieve a soft landing — where the Fed is able to achieve its 2 per cent inflation goal without a sharp rise in unemployment — compared with the December poll. Less than half of respondents expected a recession before 2026.

“The US economy is still running quite hot,” said Stephen Cecchetti, a professor at Brandeis University. “There’s still some risk of a slowdown in the second half of the year, but not as much as I would have expected three months ago.” 

Better growth could also weigh on the Fed’s willingness to cut rates, some respondents said. “I see demand in particular as stronger in the US than in European countries,” said Hilde Bjørnland, professor of economics at BI Norwegian Business School, who thinks markets will have to wait until November for the first rate cut.