MNI FED WATCH: Slowing To 25bp Pace And Debating Terminal Rate
Strong labor market data run counter to other indicators that the U.S. economy is weakening.
Federal Reserve officials are set to lift their benchmark fed funds rate by a quarter point to a 4.5% to 4.75% target range Wednesday, and may give fresh clues on how high to take borrowing costs in order to restrain demand and temper inflation.
The move will take U.S. rates to their highest since 2007 and just 50 bps short of where the FOMC in December thought they ought to pause. The quarter point pace would also be a second straight downshift of the hiking speed as inflation shows signs of easing.
The Fed's preferred measure of consumer inflation is off its summer peak, registering 5.0% in December and 4.4% excluding food and energy prices, but is still more than double the 2% target. Markets are more optimistic than the Fed that inflation will decline quickly, pricing in a below-5% peak and two quarter-point cuts by year-end.
Chair Jerome Powell will likely push back against that sentiment to stop financial conditions from loosening further, making the Fed's job that much harder. While goods inflation has come down and housing cost pressures are expected to moderate, top officials have pointed to stickier services inflation as they argue rates must climb above 5% and remain there this year.
SOFT LANDING HOPES
Cooling demand and signs of a slowdown in hiring and wage growth have raised the prospect of a soft landing, but persistently strong demand for workers could call for higher rates for longer.
Job vacancies have fallen steadily over the second half of 2022 without pushing unemployment off its 50-year low of 3.5%, while wage growth has slowed. Inflation expectations also remain well anchored.
The labor market however has proven more resilient than policymakers anticipated. Wages are still rising faster than before Covid-19 and firms report holding onto workers despite a darkening outlook, as labor supply is expected to remain weak. The recovery in labor force participation stalled out last year at below-pre-pandemic rates.
Uncertainty over whether the lag in policy transmitting to inflation has shortened in recent years also opens the possibility that the Fed might have to do more. Powell will likely re-emphasize the FOMC's view that its job is not nearly finished.