Chairman Jerome Powell achieved a near-perfect consensus as the Federal Reserve aggressively hiked interest rates. Now that the walking campaign is drawing to a close, maintaining that agreement is becoming much more difficult.
With inflation up to 9% last year, Powell’s peers were all in the fight against price pressures, with another 25 basis point hike expected on Wednesday that could be the final hike. But that consensus is already showing signs of fragmentation as inflation remains too high, while Fed officials – and many private economists – expect a recession in the coming months.
Since Covid-19 threatened the US economy in early 2020, Powell has garnered more than 98% of the Federal Open Market Committee’s vote for his actions to first boost growth during the recession and then fight inflation over the past year. Rising dissent is more likely as decisions to fight inflation or much higher unemployment become more worrisome.
“This could be a crucial meeting,” said Diane Swonk, chief economist at KPMG LLP. “We are approaching the toughest mile for the Fed in this marathon – the part where the backlash to rate hikes will intensify in a way that no one at the Fed has had to weather.”
Fed officials have signaled that the FOMC will hike rates by another quarter-point at its May 2-3 meeting to a range of 5% to 5.25%, the highest level since 2007 and part of the most aggressive tightening campaign since Paul Volcker double digit inflation four decades ago.
The economy is also being hit by tighter credit in the wake of the defaults of Silicon Valley Bank And signature bank. According to economists, this corresponds to another hike in the Fed’s interest rate by half a point or more questioned by Bloomberg, resulting in tighter conditions across all credit categories and particularly for commercial real estate, where significant losses are expected.
Another major uncertainty is the looming United States debt ceiling.
With Fed staff and two-thirds of economists predicting a recession, this puts FOMC voters in an awkward position to decide whether to continue the inflation fight or seek to cushion a slowing economy.
“Powell will have a harder time keeping the group together,” said Vincent Reinhart, chief economist at Dreyfus and Mellon, who previously worked at the Fed for a quarter of a century. “Last year, when inflation was so far above target, it was easy because that dominated their drive for purpose. There are internal disagreements that are a feature of the diversity of the board.”
Forward guidance at the May meeting could be the subject of intense debate given conflicting views on the need for a stronger hike.
March Fed forecasts show that seven out of 18 FOMC participants supported at least one more hike beyond the expected move to 5-5.25%, with one official expecting rates as high as 6%. For next year, the splits are even larger, with more than 2 percentage points difference between the upper and lower forecasts for rates.
The committee may want to adjust its language from March that it expects “additional policy tightening”, but it could be difficult to placate both political hawks and doves. Officials might also be wary of investors easing financial conditions in a way that would boost inflation.
“They have a problem here,” said Ethan Harris, head of global economic research at Bank of America corp “The outcome for the economy in the future is becoming increasingly uncertain. So they have to show some flexibility, but they don’t want to encourage the bond market to price in immediate rate cuts.”
Among the hawks, St. Louis Fed Chairman James Bullard, who is not taking part in the vote this year, has pushed for raising rates to a range of 5.5% to 5.75%, arguing that the economy is resilient and banking problems will not be too costly. Some of this sentiment was shared by Minneapolis Fed President Neel Kashkari, a constituent, and Fed Governor Christopher Waller.
Among the doves, Chicago Fed President Austan Goolsbee, a voter, has called for “prudence and patience” in assessing the impact of banking stress on the economy, and Philadelphia Fed Patrick Harker, another voter, has warned that the Fed could also act a lot and cause an accident.
“At this point I don’t see why we should just keep going up, up, up and then whoops!” he said on April 11. “And then go down, down, down real quick. Let’s sit there.”
The FOMC is forecasting unemployment to rise from 3.5% in March to 4.5% by the end of the year, a rise some say signals an impending recession. As the 2024 presidential campaign heats up, the Fed will come under more pressure to make decisions. During the 1980s, Volcker endured protests from farmers and homebuilders, the latter sending wood to the chairman to show their displeasure.
“How would you explain your view that they need to lose their jobs?” Senator Elizabeth Warren asked Powell at a Senate hearing in March.
Powell has insisted that the Fed will not ease prematurely and end the inflation fight until the Fed is confident that inflation will ease back towards the central bank’s 2% target, even if unemployment rises a bit. He said the trail could be bumpy – which could reinforce the Falcons’ view that more hiking is needed.
“It’s a difficult decision point for the Fed” as it weighs whether it’s done too little or too much, former Boston Fed President Eric Rosengren said at a Tufts University EconoFact roundtable last week. “If the unemployment rate went up too fast, that would be more of a challenge.”
–With support from Alex Tanzi.
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