The Fed’s Uniformity on Rates Comes With Risks

Whether traditionally thought of as “hawks” or “doves,” Federal Reserve officials have recently converged to notable uniformity in their policy signaling of high interest rates for longer. This has come at a time when more Wall Street analysts are embracing a wider band of uncertainty for their projections of economic growth and inflation. It is a situation that raises three risks to economic prosperity and financial stability.

Shaken by a string of hotter-than-expected readings for all the major inflation measures in the first quarter, Fed officials have become more cautious about their previous expectations for continuously softening price pressures. Chair Jerome Powell summed up this shift last week when he said that his confidence in lower inflation is “not as high” as it was at the start of the year.

With a more chastened view on inflation — and against the backdrop of a damaging mischaracterization of inflation as “transitory” in 2021 — recent speeches by Fed officials have uniformly noted the importance of giving more time for restrictive monetary policy to work. The officials have pulled back on their expectations of rate cuts, saying that April’s less troubling inflation data was not enough of a confidence boost. Indeed, as Governor Christopher Waller re-iterated on Tuesday, Fed officials are looking for “several more” good inflation prints before reducing rates.

Such uniformity doesn’t promise the economy and markets a free ride from here as it comes during a period when confidence in the Fed’s judgment and effectiveness has already been shaken. Indeed, three risks stand out.

The first has to do with how highly and, I would argue, excessively reactive the Fed has become in its policy approach or, to use the most popular Fed phrase these days, its “data-dependent” approach. This led the central bank to pivot to more dovish signaling just last December, in turn giving markets the confidence to price in six or seven rate cuts for this year. The string of favorable inflation readings that prompted the pivot then gave way to less comforting data in the first quarter and, with that, the ongoing U-turn, with markets now expecting only one or two cuts.

Such a reactive approach is problematic in a world subject to so many uncertainties. It is even more problematic for an institution whose policy tools act with a lag, and where the remaining drivers of inflation are less sensitive to interest rates.