Quagmire anyone? Fed watchers try to divine a confusing state of play

[April 30, 2024]  By Howard Schneider

WASHINGTON (Reuters) - U.S. central bankers began spreading rate-cut fever late last year, with the economy seemingly on a clear path back to low inflation and officials projecting a steady drop in borrowing costs this year, but since then the policymaking process has essentially ground to a halt.

The Federal Reserve's benchmark overnight interest rate has not budged from the 5.25%-5.50% range since July and won't be touched at a two-day policy meeting that concludes on Wednesday. Now it seems it may not be changed for a while yet.

Inflation has gone sideways since late last year - with some policymakers seeing a risk that progress is stalling - and the outlook for interest rate cuts has shifted steadily outwards with some doubt now about whether they will fall this year at all.

How to describe where the Fed stands right now? Unlike earlier in the year when the central bank's direction of travel towards rate cuts seemed clear - just six weeks ago officials saw three quarter-percentage-point cuts coming in 2024 - the recent language of veteran Fed watchers tells a muddied tale.

ON THE SIDELINES

Tim Duy, chief U.S. economist at SGH Macro Advisors, puts the Fed in the place of an athlete waiting for the moment to play, with coming data on shelter inflation holding a central place in whether policymakers can enter the game with rate cuts.

The cost of housing has been driving inflation of late, and Fed officials still expect it to decline and lead headline inflation lower.

But strong data keep undercutting confidence in a fast return of inflation to the Fed's 2% target. Some of the alternate shelter indicators watched by policymakers have shown no clear break yet.

As a result, Fed Chair Jerome Powell is expected in his press conference on Wednesday to "reinforce recent messaging that while (Federal Open Market Committee) participants still anticipate cutting rates when they have confidence that inflation is on a path to price stability, they don't anticipate having such confidence anytime soon," Duy wrote. Policymakers are "confident that shelter inflation is set to fall later this year. Under this view, the disinflation is still coming, and it has only been delayed."

'PURGATORY'

KPMG's chief economist, Diane Swonk, puts Fed officials in a deeper state of woe, what she calls "monetary policy purgatory" not so much to pay for past sins but because it's no longer certain which direction they will be going.

With inflation running faster-than-expected through the first months of this year, the Fed is "not quite sure it has done enough to derail inflation and cut rates; a further acceleration in inflation would force the Fed to consider additional rate hikes," Swonk wrote.

U.S. Federal Reserve Chair Jerome Powell holds a press conference following a two-day meeting of the Federal Open Market Committee on interest rate policy in Washington, U.S., March 20, 2024. REUTERS/Elizabeth Frantz/File Photo

"The key question is how far the Fed will want to go to shift the tenor of the debate" in the upcoming statement, Swonk wrote, putting weight on how the March 20 statement was framed in terms of the conditions under which it would be "appropriate to reduce" the benchmark interest rate.

Removing the word "reduce" or shifting to a more balanced view of the next policy step would send a particularly strong message of how recent inflation data has been absorbed.

Evercore ISI Vice Chairman Krishna Guha puts the Fed on a sort of byroad, stalled en route to a final destination that may itself become less certain.

For now he thinks Powell and the other Fed officials will try hard to keep the current baseline view of coming rate cuts intact while acknowledging recent data have not been helpful.

Guha said he expects "no changes to the statement policy language," with Powell using his press conference to repeat that the central bank is "well positioned" to just stay on hold as long as needed for the current level of rates to bring inflation down, and cut once it becomes clear that it will.

But depending on how upcoming wage and other data perform, this meeting "could end up just being a way station on the journey to a more far-reaching hawkish reset."

PATH OR TRIBUTARY?

Chicago Fed President Austan Goolsbee, known for colorful turns of phrase, has captured the shifting mood of a more complicated channel for the central bank to navigate.

Late last year he deemed the Fed on a "golden path" in which inflation was falling without any associated rise in the unemployment rate or drop in growth as has been the case in the past.

In comments earlier this month he kept the outcome the same but changed the surrounding geography.

The economy in 2023 showed "that maybe we could get the inflation down without having a big recession," Goolsbee said. "Can it continue in 2024? I hope so. But it is not going to be as extreme ... The 'golden tributary,' not the 'golden path.'"

(Reporting by Howard Schneider; Editing by Dan Burns and Paul Simao)

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