Slowing America’s rapid inflation has been an unexpectedly painless process so far. High interest rates are making it expensive to take out a mortgage or borrow to start a business, but they have not slammed the brakes on economic growth or drastically pushed up unemployment.
Still, price increases have been hovering around 3.2 percent for five months now. That flatline is stoking questions about whether the final phase in fighting inflation could prove more difficult for the Federal Reserve.
Fed officials will have a chance to respond to the latest data on Wednesday, when they conclude a two-day policy meeting. Central bankers are expected to leave interest rates unchanged, but their fresh quarterly economic projections could show how the latest economic developments are influencing their view of how many rate cuts are coming this year and next.
The Fed’s most recent economic estimates, released in December, suggested that Fed officials would make three quarter-point rate cuts by the end of 2024. Since then, the economy has remained surprisingly strong and inflation, while still down sharply from its 2022 highs, has proved stubborn. Some economists think it’s possible that officials could dial back their rate cut expectations, projecting just two moves this year.
By leaving rates higher for slightly longer, officials could keep pressure on the economy, guarding against the risk that inflation might pick back up.
“The Federal Reserve should not be in a race to cut rates,” said Joseph Davis, Vanguard’s global chief economist, explaining that the economy has held up better than would be expected if rates were weighing on growth drastically, and that cutting prematurely risks allowing inflation to run warmer in 2025. “We have a growing probability that they don’t cut rates at all this year.”
Mr. Davis’s team is an outlier in that regard: Investors more broadly still see a very small chance that the Fed will keep rates at their current 5.3 percent through 2024.
But markets have been steadily revising how many rate cuts they expect. Investors now bet that central bankers will cut rates three times by the end of the year, to about 4.6 percent. Just a month ago, they expected four cuts, and saw a reasonable chance of five.
Two big developments have shifted those views.
Inflation has been firmer than expected. The Consumer Price Index measure came in above economists’ forecasts in January and February as services inflation proved stubborn and a few goods, like apparel, increased in price.
Wholesale inflation — which measures the costs of purchases businesses make — also came in hotter than expected in data released last week. That matters because it feeds into the Personal Consumption Expenditures inflation index, a more delayed measure but the one that the Fed officially targets in its 2 percent inflation goal.
Given the data, Fed officials are likely to use this meeting to debate “whether inflation can continue to cool,” Diane Swonk, chief economist at KPMG U.S., wrote in a research note.
“The worry is that the low-hanging fruit associated with a healing of supply chains and drop in goods prices has been plucked, while a floor may be forming under service sector prices,” she explained.
The second development is that the economy still has a lot of momentum. Job gains were solid in February, though the unemployment rate ticked up, and wage growth is decelerating only slowly. If the economy retains too much vigor, it could keep the job market tight and keep wages climbing, which would in turn give companies an incentive to raise prices. That could make it hard for the Fed to wrestle inflation down in a lasting way.
The Fed does not want to cut interest rates prematurely. If the central bank fails to wrestle price increases under control quickly, it could convince consumers and businesses that inflation is likely to be higher going forward. That could make it even harder to stamp out inflation down the road.
At the same time, the Fed does not want to leave interest rates high for too long. If it does, it could hurt the economy more than is necessary, costing Americans jobs and wage gains.
Fed officials have been signaling for months that interest rates are coming soon, but they have also been trying to keep their options open on timing and magnitude.
Jerome H. Powell, the Fed chair, said in a recent congressional testimony that it would be appropriate to lower interest rates when the Fed was confident that inflation had come down enough, adding, “And we’re not far from it.”
But several of his colleagues have struck a cautious tone.
“At this point, I think the bigger mistake would be to move rates down too soon or too quickly without sufficient evidence that inflation is on a sustainable and timely path,” Loretta Mester, the president of the Federal Reserve Bank of Cleveland, said in a recent speech. That point has been echoed by other officials, including Christopher Waller, a Fed governor.
Fed officials have another policy project on their plate in March: They have signaled that they will discuss their future plans for their balance sheet of bond holdings. They have been shrinking their balance sheet by allowing securities to expire without reinvestment, a process that takes a little bit of vim out of markets and the economy at the margin.
The Fed’s balance sheet grew during the pandemic as it bought bonds in large quantities, first to calm markets and later to stimulate the economy. Officials want to shrink it back to more normal levels to avoid playing such a big role in financial markets. At the same time, they want to avoid overdoing shrinking their bond holdings so much that they risk market ruptures.
George Goncalves, head of U.S. Macro Strategy at MUFG, said he thought officials would want to make a plan for slowing balance sheet runoff first, then turn to rate cuts. He thinks the first rate reduction could come in June or July.
Michael Feroli, the chief U.S. economist at J.P. Morgan, expects a rate cut in June — and said he was dubious of the argument that it could prove harder to finish the job on inflation than it was to start it. He thinks that cooling labor costs and housing inflation will continue to slow price increases.
“We may be getting a little jumpy,” Mr. Feroli said. The idea that the “last mile” will be harder “has a nice rhetorical appeal, but then you kind of scratch down, and I haven’t been convinced.”