Inflation is still running hotter than hoped, labor markets are near full employment, and stocks and home prices are at or close to record levels. Against that backdrop of a booming economy, Federal Reserve Chairman Jerome Powell is communicating that the central bank is in no rush to cut interest rates.
“This economy doesn’t feel like it’s suffering from this level of rates,” Powell said in late March at an event at the Federal Reserve Bank of San Francisco.
Unemployment was at 2.9% in February, and inflation had ticked up to 3.2%. Economic growth is robust. What seemed like a mission to push the U.S. economy into a recession has turned into something very different. With inflation still hanging on, the Fed has been signaling that it might cut rates three times this year, half as many cuts as previously anticipated.
For the past two years, Powell and investors have been focused on the consumer price index. In 2022, inflation reached its highest levels in four decades. That prompted a strong response from the Fed, to the tune of 11 rate hikes in 2022 and 2023. The Fed’s war on inflation resulted in a retreat. However, the progress seemed to stall in early 2024, and inflation remains well above the Fed’s official target of 2%. And Fed policymakers say that until inflation moves closer to 2%, they are not eager to move.
During his appearance in San Francisco, Powell acknowledged the balancing act saying that there is a real risk in cutting rates just because everyone expects it.
“If we reduce rates too soon, there’s a chance that inflation would pop back, and we’d have to come back in, and that would be very disruptive,” Powell said. “It would not be good for the economy.”
Meanwhile, the US economy has remained resilient despite high interest rates. Inflation-adjusted consumer spending topped all economists’ estimates in February, and employers are still hiring workers at a robust clip.
“The economy is strong,” Powell said. “We see very strong growth … That means we don’t need to be in a hurry to cut.”
Of course, it would be misleading to say the U.S. economy has transformed itself. There are real issues facing those at the lower end of the income and wealth scale.
“While credit availability remains largely intact, the cumulative effect of still-high interest rates, softening demand, lower consumer savings and a mild uptick in unemployment will drive some deterioration in credit quality,” said Simona Mocuta, chief economist at State Street Global Advisors.
The housing sector also is the site of a conundrum. Home prices remain elevated, as do mortgage rates. As the Fed continues to delay rate cuts, “higher for longer” is the new reality for mortgage rates. In one illustration of the changing sentiment, Fannie Mae at the beginning of the year expected mortgage rates to fall to 5.8% by the end of 2024. Now, its forecast calls for the average 30-year mortgage rate to be at 6.4% at year’s end.
“The good news is that the housing recession is over,” said Mocuta. “The not-so-good news is that a structural shortage of housing in the United States is keeping home prices elevated and affordability constrained.”
For investors, the seesawing outlooks serve as a potent reminder that it is nearly impossible to accurately forecast the path of interest rates and the economy, particularly in the aftermath of an unprecedented event like the pandemic. Investors faced a period of intense uncertainty early in the pandemic. That was followed by a couple years of outsized returns.
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