WASHINGTON, Nov 1 (Reuters) – Throughout its two-year fight against inflation, the Federal Reserve has been trying to squeeze consumers with higher interest rates. Ability to reduce price pressure.
It hasn’t happened yet.
With financial markets expecting the U.S. Federal Reserve to leave interest rates on hold at the end of Wednesday’s two-day policy meeting, policymakers must decide whether the economy’s stronger-than-expected performance is the last gasp of a consumer boom. Evidence that monetary policy is still not tight enough to fully return inflation to the central bank’s 2% target started during the Covid-19 pandemic.
Incoming data showed stronger-than-expected job growth, stronger-than-expected economic growth and a slower-than-expected pick-up in the pace of inflation, as central bank policymakers left rates unchanged since their last policy meeting in September. That’s above the central bank’s target of 3.4% in September based on its preferred rate.
The release of new labor market data on Wednesday continued the same theme, with the number of job openings rising by 1.5 percent from September compared to the number of job seekers. The figure has caught the central bank’s attention as a sign of a persistent mismatch between the demand for workers and the number of job seekers.
As policymakers put it, there are reasons for the central bank to be „cautious” about approving any further rate hikes. Market-based interest rates, driven more by investors regardless of any central bank action, are particularly notable: Yields on long-dated U.S. Treasuries have risen since last summer and the average rate on a 30-year fixed-rate mortgage has risen to nearly 8%, a level not seen in nearly a quarter century. Ultimately, central bank officials expect these developments to slow business and household spending.
But data in recent weeks have provided little clarity on when that might happen, with long-awaited hiring, home inflation, service costs and other key data points delayed by the economy.
The bond market, meanwhile, showed why it should not be a reliable partner. Yields fell sharply after the U.S. Treasury announced it was selling less debt than expected, and the interest rate on the 10-year Treasury fell below 4.8% after hitting recent highs above 5%.
The Treasury announcement „wasn’t as bad as feared. There’s some comfort in the guidance that it’s probably only one more quarter where it’s going to increase,” said Brian Jacobson, chief economist at Annex Wealth Management in Menomonie Falls, Wisconsin.
Even rising bond yields, cited by some central bank officials as an alternative to the central bank’s own rate hikes, may be a recognition of the economy’s strength and an implicit sign that the central bank needs to do more to end the inflation fight.
„We think real rates are higher due to very strong U.S. growth,” analysts at Citi wrote ahead of this week’s Fed meeting. „If we’re right, the Fed will fall behind the real growth and inflation curve,” even if the economy slows from the 4.9% annualized pace seen in the third quarter.
Your consumers are still spending
The US Federal Reserve is due to release its latest policy statement at 2pm EDT (1800 GMT). Fed Chairman Jerome Powell will hold a press conference half an hour later.
Investors see it as certain that the central bank will keep its benchmark overnight interest rate in the range of 5.25%-5.50% set at its meeting in July.
While no updated economic or interest rate forecasts will be released at the meeting, focus will be on whether the new policy statement or Powell’s comments point toward or away from any hike.
As of the September meeting, Fed officials said they believe one more rate hike is necessary. If anything, then data may have opened that door.
GDP growth for the third quarter, combined with a low unemployment rate and ongoing healthy wage increases, along with pandemic savings, best exemplifies the risks the Fed is trying to analyze. It faced concerns that developments such as renewed student loan payments and weak consumer confidence would push people back.
Conversely, consumer-facing companies like McDonald’s and Amazon have delivered consensus-first earnings while home prices continue to rise despite high mortgage rates.
As pandemic-era programs pumped trillions of dollars into household bank accounts, economists scrambled to understand when those extra savings would run out. After the U.S. government reported eye-popping third-quarter economic growth last week, some analysts reassessed the estimate, suggesting $1 trillion more was left for food consumption and higher prices.
„Given the resilience of consumers, the risk in the very short term could be quickly reversed,” wrote Nancy Vanden Houten, a leading US economist at Oxford Economics. „There’s been a lot done with so-called 'revenge spending’ … there’s probably more room to run,” he said, referring to the surge in spending that occurred during the recovery from the pandemic.
According to the Conference Board, spending continues to grow despite consumer confidence levels, which have dipped to a recession amid several concerns.
„Consumers continue to be interested in rising prices in general, especially grocery and gasoline prices,” Dana Peterson, chief economist at the Conference Board, said Tuesday. This usually indicates an impending recession. „Consumers also expressed concerns about the political situation and high interest rates. Amid recent turmoil in the Middle East, concerns about war/conflicts also increased.”
All that was in the mind of the central bank.
Powell said in recent months that Fed policy is generally working „as expected,” with higher borrowing costs and tighter financial conditions eventually slowing the economy, but over time, savings inflation and the impact of a deeper pandemic. Misalignment between supply and demand, especially for workers.
What’s going on, in other words, is likely to be a slow, grinding adjustment toward the 2% inflation target, as the central bank doesn’t want to rush in the face of unemployment and an unwanted slowdown.
But Powell has also said growth must slow — and if that doesn’t happen, that means the Fed’s policy rate will have to go higher.
„It’s a good thing that the economy is strong. It’s a good thing that the economy has been able to hold up under the tightening that we’ve done. It’s a good thing that the labor market is strong,” Powell said at his press conference. Conclusion of September 19-20 policy meeting. But „if the economy comes in stronger than expected, we need to do more in terms of monetary policy to get back to 2%. Because we will get back to 2%.”
Report by Howard Schneider; Editing by Don Burns and Paul Simao
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