An Important Shift in Fed Officials’ Rate Stance Is Under Way
Central bank is likely to pause rate increases in September, then take a harder look at whether more are needed
By Nick Timiraos
At the Federal Reserve, further moves to tame inflation can be seen as fine-tuning. PHOTO: TING SHEN FOR THE WALL STREET JOURNALFor more than a year, Federal Reserve policy makers were unanimous that they would rather raise interest rates too much than too little—that is how serious they considered the threat of persistently high inflation.
That is changing.
Some officials still prefer to err on the side of raising rates too much, reasoning that they can cut them later.
Now, though, other officials see risks as more balanced.
They worry about raising rates and causing a downturn that turns out to be unnecessary or triggering a new bout of financial turmoil.
In addition, the unusually rapid rate increases implemented over the past 1½ years are expected to continue crimping demand in coming months.
Fed officials raised rates at 11 of their past 12 meetings, most recently in July, to a range between 5.25% and 5.5%, a 22-year high.
They appear to be in broad agreement to hold interest rates there at their Sept. 19-20 meeting, giving them more time to see how the economy is responding to increases.
The bigger debate is what would prompt them to raise rates again in November or December.
In June, most officials projected they would need to raise rates by another quarter point this year.
Projections to be released at the end of the September meeting will likely show that an additional increase is still on the table.
But whether they deliver such an increase is an open question.
For the past year, officials have placed the burden on evidence of a slowing economy to justify pausing rate increases.
As inflation cools, the burden has shifted toward evidence of an accelerating economy to justify higher rates.
This is apparent from how Fed Chair Jerome Powell recently described the risk that firmer-than-expected economic activity would slow recent progress on inflation.
Last month, he twice used the word “could” instead of the more muscular “would” to describe whether the Fed would tighten again.
Evidence of stronger growth “could put further progress at risk and could warrant further tightening of monetary policy,” he said in Jackson Hole, Wyo.
An insurance increase
One camp of officials is still anxious about inflation and wants an insurance policy against it by raising rates again this fall.
These policy makers worry about ending their tightening campaign only to discover in coming months that it didn’t go far enough.
It could be particularly disruptive if financial markets are led to believe inflation and interest rates had flattened out only to learn the opposite.
Overtightening is a risk, but “we’ve been underestimating inflation,” Cleveland Fed President Loretta Mester said in an interview last month.
“Allowing inflation to be up for longer does carry a cost for the economy.”
If it turns out such an increase had more of a negative impact than expected, “I’d be more willing to [cut] the rate a little bit faster” next year, she said.
“I don’t think one more hike would necessarily throw the economy into recession if we did feel that we needed to do one,” Fed governor Christopher Waller said last week.
Skipping a September rate rise “does not imply stopping,” Dallas Fed President Lorie Logan said.
Hold higher for longer
Another camp is more supportive of pausing increases.
They want to shift the focus from how much higher rates have to go to how long they can stay at current levels.
While the economy grew a robust 2.1% annualized in the second quarter and might grow above 3% in this quarter, these officials are skeptical this will be sustained, particularly given slower growth in China and Europe and the lagged impact of past rate rises.
“The risk of inflation staying higher for longer must now be weighed against the risk that an overly restrictive stance of monetary policy will lead to a greater slowdown than is needed to restore price stability,” said Boston Fed President Susan Collins in a speech last week.
“This phase of our policy cycle requires patience.”
Yields on the 10-year U.S. Treasury note have climbed to around 4.25% from 3.9% since the Fed’s meeting in July, raising an array of borrowing costs, including mortgage rates, which recently hit a 22-year high.
That, in effect, does some of the work that a Fed rate increase would be intended to achieve.
These officials also worry that if one more increase proves unnecessary, reversing it would be more confusing and costly than their more hawkish colleagues appreciate.
Atlanta Fed President Raphael Bostic last month said he would prefer to hold rates at current levels for the next year.
As inflation comes down, inflation-adjusted, or “real,” rates will rise.
“If we are appropriately cautious, we have the opportunity to minimize the damage that we see on the employment side.
That’s not to say there won’t be damage,” he said.
Measures of underlying inflation that strip out the most volatile price changes have shown a sustained decline this summer.
One from the New York Fed dropped below 2.8% in July from a high of 5.5% in June 2022.
Other data show the frequency and magnitude of price increases, which accelerated in 2021, have also retreated.
The fine-tuning stage
To be sure, the difference between one more rate increase and none might not be that great in the scheme of things.
“Is one going to be right and the other demonstrably wrong?
I’m very doubtful,” said Nathan Sheets, a former senior Fed economist who is now chief economist at Citigroup.
“What’s left now is fine-tuning.”
Other economists outside the Fed say spending and growth data can overstate the economy’s strength ahead of a slowdown.
“This is how policy accidents always occur: a fixation on backward-looking data,” said Daleep Singh, chief global economist at PGIM Fixed Income.
“Most of the forward-looking indicators now suggest that while restrictive policy may still be appropriate,” the degree of restraint being delivered by high real rates might soon be “more than this economy can handle,” he said.
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