The inflation problem is largely behind us, and most signs suggest that Federal Reserve policymakers know it. So why didn’t they just go ahead and cut rates on Wednesday instead of leaving their target range at 5.25% to 5.5%? Why wait until March or (more likely) May?
Outside of obvious recessions, that’s just the way they do things at the Fed: very, very slowly.
It’s often said that adjusting central bank policy is like turning a tanker. Policymakers spend months preparing markets for changes, then execute them as gingerly as the circumstances will allow. I’d argue that’s partially due to the challenges of consensus-building on the Fed’s rate-setting committee, as well as the central bank’s understandable desire to avoid unduly injecting volatility into financial markets.
But there are also tradeoffs.
In the current context, the greatest risk is that the Fed will place so much weight on moving slowly and overcommunicating that it will risk its chance at a soft landing. As wonderfully as the economy performed in the second half of 2023, it’s always more vulnerable to shocks when monetary policy is especially tight. The recent troubles at New York Community Bancorp — whose shares tumbled 38% on Wednesday — show that regional bank and commercial property risks remain chinks in the economy’s armor that can sneak up on policymakers very quickly. That in and of itself might be a good reason to expedite the Fed’s first policy rate cut and bring forward the tapering of quantitative tightening, the Fed’s liquidity-sucking balance sheet reduction program.
But at his press conference on Wednesday, Fed Chair Jerome Powell told reporters that, although most policymakers expect cuts are in the cards, they intend to wait for a while longer. Here’s the remark that really crystallized that outlook for markets:
We’re going to be looking at this meeting by meeting. Based on the meeting today, I would tell you that I don’t think it’s likely that the committee will reach a level of confidence by the time of the March meeting to identify March as the time to do that. But that’s to be seen.
Meanwhile, here’s how he described his sense of urgency (or lack thereof) on QT tapering:
So at this meeting we did have some discussion of the balance sheet and we’re planning to begin in depth discussions of balance sheet issues at our next meeting in March. So those questions are all coming into scope now and we’re focusing on them, but we’re at the beginning of that process.
In other words: Relax! We’ll get to it when we get to it!
On the policy rate in particular, Powell says that officials are waiting for more evidence that inflation is sustainably heading back to the 2% target. Not better evidence, mind you — just more of it. On a six-month annualized basis, the core personal consumption expenditures deflator is already running at a below-target 1.9%.
It’s possible, of course, that the whole discussion of rate-cut timing will end up being meaningless. The real economy is in an almost too-good-to-be-true run of strong, productivity-driven, non-inflationary growth that’s been helping to keep unemployment low. And my best bet is that will continue for a while. Real wages are still rising and consumer confidence improving, fueling a virtuous cycle.
But there’s no reason to push our luck, either. Serious geopolitical risks continue to mount, and commercial real estate’s problems continue to fester. Meanwhile, declining balances in the Fed’s overnight reverse repurchase facility could make the effects of QT more palpable in the months to come. All of this suggests that the risks to the Fed’s full employment mandate are a bit higher than the threat of resurgent inflation. And yet the Fed is passively tightening policy by holding nominal rates high as inflation falls. So why wait for a problem to materialize before taking concrete action?
The Fed hasn’t always been slow, of course. The Powell Fed reacted swiftly and admirably during the Covid-19 pandemic, and Powell deserves much praise for the rescue that he marshaled. But when inflation appeared in early 2021, the Fed reverted back to its slug-like traditions, hamstringing itself with forward guidance and waiting close to a year to meaningfully change policy. Based on Wednesday’s press conference with Powell, it sounds like the Fed now finds itself back in go-slow mode, a setting that — tradition aside — doesn’t seem to make a lot of economic sense and unnecessarily puts the chances of a soft landing at risk.
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