The Fed might not be done raising interest rates just yet

Interest rate cuts have been the main focus for Wall Street ever since the end of last year, when Federal Reserve officials indicated they intended to lower rates. But stubborn inflation now has some investors wondering about the exact opposite: a rate hike.

Inflation slowed substantially in 2023 as the Fed lifted rates to nearly a quarter-century high and held them at that level since July. But recent economic data shows there hasn’t been much improvement this year.

Then came March’s Consumer Price Index report, which showed prices rose 3.5% last month from a year earlier, up considerably from February’s 3.2% and higher than economists’ expectations. That also marked the highest reading in half a year.

Surging gas prices and still-high housing costs drove the hotter-than-expected reading. The report spooked Wall Street, triggering a mass selloff on Wednesday and reducing the odds of a June rate cut, according to futures.

Still, most Fed officials have signaled that they plan to cut rates this year if the economy evolves as expected. But disappointing inflation readings like Wednesday’s are likely giving them pause. And if the inflation situation worsens even further, the Fed may even have to consider raising rates.

Fed Governor Michelle Bowman, arguably the central bank’s most hawkish voice, recently said that she would favor a rate hike “should progress on inflation stall or even reverse.”

Minneapolis Fed President Neel Kashkari last week floated the possibility of not cutting rates at all this year. He also said rate hikes are “certainly not off the table.” But he said they aren’t likely. Kashkari is not voting on monetary policy decisions this year.

Like Bowman and Kashkari, New York Fed President John Williams said rate hikes aren’t part of his baseline outlook. But he said he’s not even remotely considering a rate increase at the moment.

“I don’t see any signs that we’re not having the desired restricted effect on demand that’s helping us achieve our goals,” Williams said in response to a question posed by CNN at a Thursday discussion with reporters. There are “definitely circumstances” that would merit raising interest rates, he added, such as inflation moving materially higher, but the current trajectory doesn’t fit that, he said.

Williams, a top adviser to Fed Chair Jerome Powell, still believes it will be appropriate to cut rates later this year, but declined to specify the quantity and timing.

Boston Fed President Susan Collins said Thursday: “Overall, the recent data have not materially changed my outlook, but they do highlight uncertainties related to timing, and the need for patience — recognizing that disinflation may continue to be uneven,”

Last month’s shockingly strong job report — the economy added 303,000 jobs in March, blowing past expectations of 205,000 positions added — is more of a reason for the central bank to be patient with cutting rates, she said, adding that it may mean fewer cuts this year “than previously thought may be warranted.” Collins, who isn’t voting on policy decisions this year, said at the end of last year, when CPI was lower than it is currently, that more rate hikes weren’t off the table.

Powell, meanwhile, hasn’t recently addressed the potential need to raise interest rates. He said last month that the hotter-than-expected inflation reports for the beginning of the year might have been due to “seasonal factors.”

But not all Fed policymakers agreed with that assessment during the March meeting, saying that “the recent increases in inflation had been relatively broad based and therefore should not be discounted as merely statistical aberrations,” according to meeting minutes released Wednesday.

For now, officials generally expect to cut rates at some point this year. Officials’ latest economic projections show that they mostly expect to cut rates this year, though they were split on how aggressive the cutting should be, with 10 expecting three or more quarter-point cuts and nine estimating two or fewer.

Former Treasury Secretary Larry Summers said Wednesday the March CPI report raises the odds that the Fed will hike rates.

“You have to take seriously the possibility that the next rate move will be upwards rather than downwards,” Summers said in a Bloomberg TV interview Wednesday.

Summers was one of a handful of economists who correctly argued back in 2021 that inflation wasn’t transitory, as Fed officials had categorized it, and rather was more widespread and would prove to not be temporary.

Since Wednesday’s CPI report, economists from major banks including UBS, Barclays, Goldman Sachs and Bank of America have all pushed back their forecasts as to the timing of the first rate cut.

Bank of America economists, for instance, are now predicting only one rate cut this year, in December. Previously they called for as many as four, with the first coming as soon as March.

“2024 is starting to look like 2015, but in reverse. Then the Fed signaled hikes it could not deliver; now the Fed may be signaling cuts that the inflation data do not justify,” they said in a note Thursday.

The timing of that first rate cut is critical because if the Fed cuts too soon, it risks locking in inflation at a high level. If the central bank cuts too late, it could unnecessarily damage the economy. That’s why the Fed is waiting for more data before making any conclusions about the economy, including whether inflation has indeed stalled.

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