Federal Reserve Adjusts Interest Rates: Signaling the Job’s Not Done Yet

The Federal Reserve is expected to announce a 25 basis-point increase in interest rates on February 2, 2023, bringing the benchmark to a target range of 4.5% to 4.75%. This comes after the December 2022 increase of 50 basis points and four 75 basis-point hikes in the previous year. The Federal Open Market Committee is relying on their statement and Chair Jerome Powell’s press conference to emphasize that the policy rate is likely to stay at its peak for a while.

The recent economic reports suggest that the US economy is responding to the Fed’s rate increases with moderating price pressures and cooling growth. However, the tight labor market could still add more pressure on the Fed to hold rates at restrictive levels for longer or extend its tightening campaign. Data from the Labor Department’s Job Openings and Labor Turnover Survey showed an unexpected increase in vacancies at US employers to a five-month high in December 2022.

Policymakers believe that rates need to get above 5% and stay there for the higher borrowing costs to take effect. One thing to watch for is whether Powell refers to the Fed’s December forecasts, which showed rates rising to a median of 5.1% this year. Inflation data, showing prices cooling faster than expected, could provide clues on the Fed’s confidence that inflation is peaking.

There is speculation on whether it is time for the Fed to adjust its statement that says “ongoing increases” in rates will be appropriate. Some economists are watching for the Fed to formalize its forward guidance that rates will stay at restrictive levels for “some time.” Keeping rates at high levels for a while allows the central bank to keep tightening policy discreetly as inflation comes down.

Financial conditions are the loosest they have been since February 2022 as investors bet on declining inflation and a potential rate cut later this year. This could work against the Fed’s efforts to bring down inflation. Fed officials are concerned about the “unwarranted easing” of financial conditions, as shown in the December meeting minutes. Chair Powell could be asked about the debt ceiling negotiations in Washington and their potential impact on the US economy.