Where Are Interest Rates Headed? What to Expect From the Fed Meeting
Officials are likely to leave rates unchanged and could temper investors’ expectations of earlier rate cuts
Federal Reserve officials are set to hold interest rates steady this week at a 22-year high and will likely project cutting them next year.
Still, they won’t declare an end to rate hikes this week, even though they are growing more convinced that they have done enough to bring inflation down.
Officials will release a new policy statement and economic and rate projections at the conclusion of their two-day meeting, Wednesday at 2 p.m. Eastern time. Fed Chair Jerome Powell’s press conference at 2:30 p.m. will be heavily parsed for clues about when and why the central bank might shift its policy stance next year.
Here’s what to watch for:
The policy decision
After raising interest rates last year at the fastest pace in 40 years to combat inflation that soared to four-decade highs, Fed officials slowed the pace of increases this year to see how the economy was responding. They raised their benchmark federal-funds rate by a quarter-point at four meetings this year, most recently in July, to a range between 5.25% and 5.5%.
By holding rates steady this week, officials will extend their rate-hike pause to six months because their next meeting is at the end of January.
Officials are likely to maintain language in their policy statement that suggests their next rate change is more likely to be an increase than a cut. Any softening of this so-called tightening bias will be closely watched by financial-market participants because it could be a precursor to a neutral stance in January or March—meaning their next change is as equally likely to be a hike as a cut. And a neutral bias could be a precursor to a rate cut.
The economic projections
Inflation is on track to end the year slightly lower than what Fed officials projected in September. Officials then expected core prices, which exclude volatile food and energy prices, to be 3.7% higher in the fourth quarter of 2023 than a year earlier. Core inflation was 3.5% in October, according to the Commerce Department.
Much of the slowdown has occurred recently. Core inflation was 2.5% at an annualized rate over the six months through October, down from 4.5% over the previous six-month period, according to the Commerce Department.
In September, most officials projected one more rate increase this year and then penciled in at least two rate cuts next year, which would leave the Fed’s benchmark rate at around 5.1% by the end of 2024. One big question this week is how officials revise their projections for inflation and interest rates for next year.
If officials project that rates will still end next year at 5.1%, that would result in just one rate cut, assuming no additional increases. If officials maintain their projection of two rate cuts despite not hiking again, that would lower the year-end projection to around 4.9%.
Investors in interest-rate futures markets anticipate the Fed will cut rates by 1 percentage point next year, implying four cuts of a quarter-point. Any Fed projection of more than two rate cuts next year would likely cheer markets by validating expectations of an earlier turn toward cuts than most officials have publicly supported.
Officials find themselves in “a weird situation because you don’t want to say ‘We’re not going to cut,’ and then end up cutting rates five times next year. But if they say, ‘Four cuts next year,’ then the market might price in six or seven cuts, and they don’t want that,” said Jón Steinsson, an economist at the University of California, Berkeley.
The press conference
Powell’s press conference could focus heavily on a topic officials have been reluctant to discuss: when rate cuts are coming. Officials don’t want to declare victory yet on inflation or cause a market rally that makes it harder to sustain the slower economic growth they believe necessary to conquer inflation.
“The market is a little carried away on the possibility of near-term cuts,” said Antulio Bomfim, a former adviser to Powell who is now at Northern Trust Asset Management. “My expectation is that he will gently push against that view.”
The reasons why officials lower rates matter. Often, the central bank trims rates to shore up a deteriorating economy and job market. Indeed, this forms the basis for several analysts’ forecasts of cuts next year.
Matthew Luzzetti, chief U.S. economist at Deutsche Bank, expects the Fed to begin cutting rates in June and to lower the fed-funds rate to around 3.5% next year as the economy slides into recession. Under this scenario, “the case for cutting rates would be very, very clear for the Fed,” he said.
But Fed officials have acknowledged that they could lower rates next year simply because inflation is well on its way to their 2% target. Holding rates steady as inflation falls would lead inflation-adjusted or “real” rates to rise, which the Fed doesn’t want. Officials could lower nominal rates simply to prevent real interest rates from turning too tight.
Risk management and rate cuts
Markets are craving a degree of clarity that Powell isn’t likely to offer.
Fed officials are trying to balance the risk of moving too slowly to ease policy, which could lead the economy to slump under the weight of its past increases, against the risk of easing prematurely and seeing inflation settle above 3%—well above their 2% target.
It is likely too soon for many officials to be confident that they have done enough to keep inflation declining to 2%, said Vincent Reinhart, chief economist at Dreyfus and Mellon. “We are going to be in a period that’s got to feel very unsatisfactory for them,” he said.
James Bullard, who stepped down in July as president of the St. Louis Fed, said he would want to see the 12-month core-inflation rate drop below 3% before entertaining cuts.
He worries about a “worst-case scenario” where the Fed cuts rates and then inflation stalls out at 3% or even reaccelerates. “That would put the committee and markets in a very difficult situation, so why get into that if you don’t have to?” said Bullard, who is now dean of the Daniels School of Business at Purdue University.