The Fed isn’t ready to cut interest rates yet, but it is getting close

The Federal Reserve has made significant progress against inflation, but policymakers are waiting for a few more months of good news before deciding they are ready to cut interest rates for the first time since the pandemic began in 2020.

Wrapping up their first meeting of the year, central bankers left rates unchanged. They highlighted how far the economy has come since the Fed sprinted to hoist borrowing costs as inflation soared to 4o-year highs. But the ever-cautious Fed policymakers stopped short of declaring victory, instead opting to gather a bit more data and cement their confidence in the meantime.

“Implicitly, we do have confidence, and it has been increasing, but we want to get greater confidence,” Fed Chair Jerome H. Powell said at a news conference Wednesday. “We’re looking for a continuation of the good data that we’ve been seeing.”

The Federal Reserve left interest rates unchanged on Wednesday, but central bankers indicated they’d probably cut rates in March/the coming months for the first time since 2020.

The Financial markets are hungry for any specific timeline. But Powell appeared to nix the possibility of a first interest rate cut when officials convene again in March. Markets dropped into the red Wednesday on signs that a much-anticipated rate cut might not come until later meetings in May or June.

“I don’t think it’s likely that the committee will reach a level of confidence by the time of the March meeting,” Powell said. “But that’s to be seen.”

What isn’t up for debate, though, is that the economy has shown remarkable strength in the face of high rates. Inflation has eased considerably, especially over the past six months. And though prices are higher than before, rapid increases are no longer a scourge on American life.

Fresh data last week showed that the Fed’s preferred inflation gauge dropped to an annualized rate of 1.7% at the end of 2023, slipping below the Fed’s 2% goal for the first time since prices took off.

That happened even as other parts of the economy grew at a healthy clip. The unemployment rate is at a tight 3.7%, and employers averaged 225,000 new jobs per month in 2023. The economy also grew by a whopping 3.3% in the last three months of 2023, surpassing expectations and showing how robust consumers’ pocketbooks remain.

“The underlying story in the data remains very constructive, and there’s nothing here that discourages me from thinking that the Fed will more likely cut than not cut in May, and will certainly cut by June,” said Krishna Guha, vice chairman of Evercore ISI. “I just think they’re being careful, and they have the luxury of being able to do so.”

For almost two years, officials have been focused on raising interest rates and keeping them high enough to tame inflation and meaningfully slow the economy. That sprint brought the Fed’s benchmark rate to between 5.25 and 5.5%, the highest level in more than two decades. The aggressive policies sent borrowing costs for all kinds of loans and investments way up, from mortgages to auto loans and more.

Officials weren’t expected to tinker with interest rates at this week’s meeting. The bigger question was how quickly they would start pivoting into a new phase of policymaking.

Typically, Fed officials shy away from being too specific about their plans, since the economy has repeatedly veered in unexpected directions. But the central bank also doesn’t like surprises, and once it feels confident that a cut is on the table, it would want to give financial markets a heads up.

That’s a delicate balance, especially since Fed officials have increasingly been talking about the risks of waiting too long to cut rates and possibly hurting the strong labor market as a result. On the flip side, there are hazards to moving too hastily and giving inflation a change to reignite.

“If we saw an unexpected weakening in the labor market, that would certainly weigh on cutting sooner. Absolutely,” Powell said. “If we saw inflation being stickier, or higher, or those sorts of things, [that] would argue for moving later.”

The prospect of rate cuts comes after some very bumpy years for the central bank. In 2020, the Fed slashed interest rates to near zero in a fierce attempt to rescue the economy from the covid recession. Then in 2021, officials held off raising rates even as inflation took off, betting the price hikes would be temporary and eventually shake out of the economy.

Come 2022, the Fed was in a mad dash to hoist rates and catch up with inflation that soared to 40-year highs, sped along by broken supply chains and the energy shock that followed Russia’s invasion of Ukraine. Then, over the past year, the Fed slowed its pace but made clear it would keep pressure on the economy until inflation was fully vanquished. Now, the economy is in a vastly different place than when the Fed kicked off its rate hike campaign.

The general picture has dashed any expectations of a recession. But incoming data could sharpen policymakers’ understanding of where major metrics stand at the start of 2024. A key manufacturing index gets updated Thursday, and Friday brings the January jobs report. There are also two more inflation reports before the Fed’s March meeting.

But barring some unforeseen shock, those reports seem unlikely to shatter the economy’s resilience. Powell wouldn’t go so far as to say the Fed had officially achieved a “soft landing,” an end to runaway inflation without a recession. But so long as inflation, growth, the labor market and consumer spending stay on track, the possibility is nearing.

“It’s a good labor market, and we’ve seen inflation come down,” Powell said. “So we’ve got six months of good inflation data and an expectation that there’s more to come. So this is a good situation, let’s be honest. This is a good economy.”