Experts are engaged in a heated debate over the Federal Reserve’s approach to interest rates, given the current state of the job market and easing inflation. The Fed’s previous delay in raising interest rates allowed consumer prices to climb sharply, and now there are concerns that they may be moving too slowly to cut rates, potentially triggering a recession. Mark Zandi, chief economist of Moody’s Analytics, warns that the longer the Fed waits, the greater the risk of something going wrong. He suggests that the Fed should start lowering rates in March or May at the latest.
However, Fed Chair Jerome Powell has stated that a rate cut in March is highly unlikely. The minutes of the Fed’s late January meeting have led some economists to push their predictions for the first rate decrease to June or later. Many economists believe that inflation still poses a bigger threat and that the Fed is on the right track by being patient. Barclays economist Mark Giannoni agrees with this sentiment, stating that he thinks they are right to be patient.
The current Fed interest rate was raised from near zero to a 22-year high of 5.25% to 5.5% between March 2022 and July 2023. Since then, the rate has remained steady. Lowering the benchmark rate would reduce borrowing costs for mortgages, credit cards, cars, and other consumer and business loans, stimulating the economy. The prospect of lower rates has already driven the stock market to record highs.
Powell has emphasized the need for more confidence that inflation is on a sustainable path down to 2% before considering a rate cut. The minutes of the meeting reveal that most policymakers are concerned about the risk of acting too quickly and reigniting inflation. Only a few officials pointed out the hazards of keeping rates high for too long and causing the economy to weaken significantly or slip into a recession.
While some reports seem to support the Fed’s cautious approach, with a core inflation measure showing a 0.4% increase in January and an annual rise of 3.9%, there are differing opinions. Zandi argues that the increase in inflation in January was mainly due to persistent rent and housing cost increases, which are expected to ease in the coming months. He also points out that the personal consumption expenditures (PCE) price index, which the Fed closely monitors, was at 2.6% in December, and the Fed’s preferred core reading was at 2.9%, not far from the 2% target. Zandi suggests that by annualizing the increases in core PCE prices over the past six months, inflation is already at 1.9%.
Zandi raises concerns about the economy, stating that although job gains have been strong, the rate of hiring hit its lowest level since 2014 in November. He argues that net job gains have been strong because employers have been reluctant to lay off workers following severe COVID-related labor shortages. Additionally, while the gross domestic product (GDP) grew last year, an alternative measure of economic output, gross domestic income, has increased feebly. Zandi believes that the risk of tipping the economy into a recession is now greater than the chances of nudging inflation higher.
Ryan Sweet, chief U.S. economist at Oxford Economics, agrees with Zandi, stating that if the central bank waits for clear signs of economic deterioration, it will be behind the curve. Zandi also expresses concerns about an unforeseen banking crisis and businesses cutting employees to maintain earnings as high rates boost costs and dampen sales.
Economists project economic growth to slow to 2.1% this year, with a 36% chance of recession, according to a survey of forecasters. However, this is down from 61% odds in May. Zandi argues that the Fed’s key rate should already be at 4% instead of 5.25% to 5.5%, based on a model that considers various economic indicators.
While some economists believe that the risks of another price surge versus a recession are becoming more balanced, Giannoni thinks that inflation is still the bigger worry. He points out that prices of services such as healthcare, auto insurance, and dining out have continued to increase sharply. However, he does not see a high probability of high interest rates toppling the economy into a downturn.
In conclusion, experts are divided on the Federal Reserve’s approach to interest rates. While some argue for an immediate rate cut to prevent a potential recession, others believe that the Fed is right to be patient and prioritize the threat of inflation. The current state of the job market and easing inflation are key factors in this debate. Ultimately, the Fed’s decision will have significant implications for the economy and various sectors, including housing, lending, and business profitability.