The US Federal Reserve is hurtling towards one of the toughest calls of its monetary tightening campaign as it decides whether to switch back to more aggressive rate rises at a time of acute economic uncertainty.
This week, chair Jay Powell warned the central bank might have to return to half-point rate rises at the conclusion of its next meeting on March 22. But he said the final decision hinged on a series of crucial forthcoming data releases, which will be published either during or just before a “blackout” period when the Fed is all but forbidden from communicating publicly.
That means the Fed might not only be forced to make a significant departure from the path Powell laid out just over a month ago, when the central bank called time on a string of “jumbo” rate rises and opted for a more typical quarter-point cadence. It also means it has a short window to signal its thinking to investors.
“They’re getting spooked, and why wouldn’t they be?” said Derek Tang, an economist at research firm LH Meyer.
“It’s their reputation at stake now and reputation is something that is very hard to earn back once you lose it,” added Tang, who predicts the Fed will opt for a half-point rate rise.
At the conclusion of the Fed’s most recent meeting earlier this month, Powell said the “disinflationary process” was under way, prompting a relief rally in markets and leaving the impression the US central bank had finally turned a corner in its fight against soaring prices. However, since then a surge in job creation coupled with the hotter-than-expected inflation and spending data has complicated the Fed’s calculus.
Powell has been at pains to point out that the Fed has not yet decided on a half-point rate rise over a smaller increment. “We’re not on a preset path,” he said during congressional testimony this week. “We will be guided by the incoming data and the evolving outlook.”
Whether the Fed chooses to go bigger or smaller depends in large part on two data releases that officials are waiting for with bated breath: the next jobs report on Friday and fresh consumer price data on Tuesday.
Those releases will help the Fed decide whether the hotter-than-expected releases last month were “fluky”, perhaps because of unseasonably warm weather at the start of the year, according to William English, a former director of the Fed’s division of monetary affairs.
“If February looks bad and confirms some of what we saw in January, then I think they probably do conclude they have further to go than they thought,” said English, who is now at Yale University. In that case, a half-point rise “might well feel like a safe bet to get back on the path that they need”, he added.
Another complicating factor for the Fed is the jobs report will be released just hours before it enters the blackout in the early hours of Saturday morning. After that, officials are forbidden from making public statements that are heavily parsed by investors for signs of which way the Fed is leaning. Meanwhile, the inflation number will be released in the middle of the quiet period, along with data on retail sales and manufacturing inflation.
Futures markets now suggest odds of roughly 80 per cent that the Fed will opt for a half-point rate rise, according to the CME Group.
Economists at Citigroup warn that if the Fed blinks and sticks with a quarter-point rate rise, it could result in an “unhelpfully large easing of financial conditions”.
Tang from LH Meyer also warned that the economic data will not be “ambiguous enough” to allow the Fed to stick with a quarter-point increase. For Tiffany Wilding, North American economist at Pimco, payrolls growth of about 300,000 on Friday would clear the path for the more aggressive option.
The prospect of a half-point rate rise has also upended expectations about how far the Fed will lift its benchmark rate this year. It has already raised it to just below 4.75 per cent. Powell this week said the “ultimate level of interest rates is likely to be higher than previously anticipated”.
In December, most officials saw the fed funds rate topping out somewhere between 5 per cent and 5.25 per cent. Fresh projections will be released alongside the rate decision this month, with many economists now expecting those forecasts to be revised upwards by at least half a percentage point to 5.5 per cent to 5.75 per cent.
“What gets him to stop? The economy has to shift pretty sharply,” said Harris of Powell. “We need to see the job market cool off dramatically, with job growth down to zero and the unemployment rate inching up.”
