What Will the Federal Reserve Do Now?
Some data suggests a cut in interest rates is due. Other data suggests raising interest rates is not out of the question.
In June 2022, when the annual inflation rate peaked at 9.1%, the Federal Reserve began to raise interest rates. The rate hikes took the Federal Funds rate from near zero to over 5.25% by July 2023. Then the Fed stopped raising interest rates and in December it predicted it would cut rates three times in 2024.
Now that it is June with no rate cuts, what will happen by the end of this year?
The unprecedented rapid rise in the Federal Funds rate in the 13-month period from June 2022 to July 2023 brought the inflation rate, as measured by the Consumer Price Index, down to 3.1%. Based on that rate, the Fed made its forecast of three interest rate cuts in 2024. As late as March of this year, the Fed was still predicting three rate cuts.
Last December, some Wall Street experts foresaw as many as six interest rate cuts in 2024.
At the time, I forecasted that there would be no interest rate cuts in 2024 and I wouldn’t be surprised if the Fed raised rates one or two times.
The Fed’s latest forecast was that there will be one rate cut by the end of the year. I believe there will be no rate cuts this year, even though the economy is slowing. First quarter annual gross domestic product growth slowed to 1.3%. It looks like the second quarter growth rate will be in a similar range.
Usually that would encourage the Fed to cut interest rates. Not this year. While the restrictive monetary policy from June 2022 to July 2023 did bring the inflation rate down to 3.1%, the inflation rate has increased since then, and while it does fluctuate, the current rate is 3.3%.
Fortunately, energy prices have stabilized, helping to keep inflation down. But with the continued huge deficits the federal government is incurring with its massive spending and with the current wage inflation, it is difficult to see inflation falling below 3%.
That means it will be difficult for the Fed to reduce interest rates.
The second quarter GDP growth number will be estimated at the end of July. If the economy is weaker than expected, there will be pressure on the Fed to reduce interest rates. However, if GDP growth is stronger than expected, as the Atlanta Federal Reserve Bank currently predicts, the Fed will not reduce interest rates.
So, what will the Fed do for the rest of the year?
It appears that the inflation rate will not fall much further by year end. If there are some increases in energy prices, inflation could increase. That leaves the Fed with a dilemma.
If Federal Reserve officials err, they will err to the side of being too aggressive. That’s because they made two errors in the past that they don’t want to repeat.
The first error was that they left interest rates near zero from January 2021, when inflation began to increase, to June 2022 when inflation reached 9.1%. That costly error forced them to aggressively raise interest rates after June 2022. Had they started in early 2021 to gradually raise rates, inflation would not be the problem that it is today.
Their second error was they stopped raising interest rates in July 2023. Had they raised rates in September and again in December, the inflation increase we saw from the end of last year to today would not have happened.
I continue to stay with my original forecast made at the end of last year: There will be no rate cuts at all this year and indeed a rate increase is not out of the question.
Inflation is a cancer and must be treated early and aggressively. The Fed did not treat the problem early, so they must treat the inflation problem aggressively today, even if it slows the economy and brings on a mild recession raising unemployment.
Inflation negatively impacts nearly the entire population. Increased unemployment impacts only a few percent of the population. The Fed’s top priority today must be to reduce inflation before it gets embedded into the system.
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