Interest rate cuts may not come so soon amid strong job growth and persistent inflation.
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US Federal Reserve chair Jerome Powell damped expectations of impending interest rate cuts on Tuesday — a sign that the Fed may have pumped so much money into the economy during the pandemic that the surplus is still making its way through the country.
Speaking on a panel discussion at the Wilson Center in Washington, Powell said while inflation pressure has eased in the last year, it hasn't come down enough in recent months.
"The recent data have clearly not given us greater confidence and instead indicate that is likely to take longer than expected to achieve that confidence," Powell said Tuesday
This means that the Fed isn't confident at this point that inflation is headed to its 2% target level in the longer term.
Strong job growth is contributing to price gains. In particular, the Personal Consumption Expenditures Price Index — a key inflation metric for the Fed — was little changed in March over its 2.8% reading in February, Powell pointed out.
So the Fed can keep interest rates higher for longer to cool price rises — although the central bank also has room to cut should the labor market "unexpectedly weaken," Powell added.
"If higher inflation does persist, we can maintain the current level of restriction for as long as needed," he said.
Higher interest rates make borrowing more expensive for anything from mortgages to credit cards — it encourages people to save rather than spend, which in theory, helps bring down prices. But it takes a while for the effects to be felt, and the risk is that the central bank raises rates to the point where the economy slows down and even tilts into recession as demand contracts.
Conversely, lower interest rates encourage borrowing and spending — thus driving the economy when growth slows, such as during the COVID-19 pandemic when the Fed cut rates massively and pumped money into the system.
Powell's comments on Tuesday were a departure from just a month ago, when Fed officials stuck to their expectations of three rate cuts this year.
They also illustrate the Fed's tricky balance as it tries to steer the US economy into a "soft landing," thus averting a recession.
Jim Reid, a research strategist at Deutsche Bank, wrote in a note on Tuesday that he believes it will be "incredibly difficult" to achieve a soft landing for the US economy because it's moved from the largest jump in the money supply since the World War II to the largest contraction since 1930.
Even though the Fed has tightened the money supply — hiking interest rates 11 times since March 2022 — the scale of the COVID-19 stimulus and money supply is still taking time to work through the system, Reid added in the note published before Powell's comments on the same day.
But Reid thinks the excess money could be drained from the economy later this year, when money supply in the economy normalizes.
"If that's correct, then maybe cutting rates in preparation for that is actually the correct thing to do," said Reid. "However, faced with inflation that is currently accelerating, that would be very, very difficult for the Fed to communicate and be comfortable doing."
Deustche Bank is just pricing in one Fed rate cut, in December 2024.
To be sure, money supply isn't the only thing that contributes to inflation.
As Bill Dudley, a former president of the Federal Reserve of New York, explained in an opinion piece for Bloomberg in February 2023, other factors influencing the US economy include consumer demand and stimulus money, and the Fed keeping rates "too low for too long."
"If rates had been considerably higher, earlier, the economy would have grown more slowly, the labor market wouldn't be as tight and wage and price inflation would be lower," wrote Dudley.
Fed Chair Powell had said inflation was "transitory" amid the COVID-19 pandemic but stopped using the term in 2022 amid persistent price rises.
The Fed will gather on April 30 to May 1 for its next policy meeting.
