Fed’s hikes not only factor easing inflation
Things look a lot brighter at the Federal Reserve than they did a year ago, as the central bank kicks off its July policy meeting on Tuesday.
Back then, inflation was peaking at 40-year highs, and the Fed was sprinting to keep up.
Now inflation has fallen every month since June 2022. Major Wall Street firms see only a dwindling prospect that higher interest rates will cause a recession this year. And stock indexes have climbed near levels not seen in more than a year.
But with the Fed poised to raise rates this week for the 11th time in 16 months, it’s an open question exactly how much their aggressive moves have tamed prices and how much credit should go to other factors beyond the central bank’s control.
The distinction matters as the Fed debates how much higher to raise rates and scans for signals that its policies are working. Compounding the challenge is that all of the hikes up to now won’t hit the economy with equal force or on a predictable timetable, blurring central bankers’ understanding of how much harder they need to push.
“A lot of the work in terms of disinflation so far does go to this unwinding of transitory effects,” said Harvard economist Karen Dynan, referring to the idea that many sources of inflation could turn out to be temporary. “But that’s not to say the Fed’s actions have been irrelevant, or haven’t had any impact.”
In June 2022, inflation peaked at 9.1 percent, driven overwhelmingly by a surge in energy prices after Russia’s invasion of Ukraine. Gas prices were topping $5 a gallon. High utility and diesel costs seeped into prices for food, airfare and trucking. Meanwhile, supply chains that got pummeled during the pandemic struggled to clear their backlogs as consumers shopped for everything from used cars to refrigerators to couches.
But over time, things improved. Inflation trended down, even while Fed officials cautioned the path would not be smooth. The economy had more time to absorb the historic government stimulus from 2020 and 2021, which turbocharged consumer demand. By last month, the consumer price index had ticked down to 3 percent, the lowest level since March 2021. Now increases are primarily driven by high costs for rent, rather than energy or goods prices. (The Fed has a different inflation metric that it prefers, but that measure tells a similar story.)
Central bankers aren’t ready to declare victory yet. But for the first time since March 2022, the Fed left rates unchanged at its last meeting to leave some time to assess the economy. Policymakers are widely expected to announce a quarter-point hike at the conclusion of their two-day meeting on Wednesday, which would bring the federal funds rate to between 5.25 and 5.5 percent.
In addition to this week’s expected hike, Fed leaders have already signaled they plan to raise rates one more time this year. Yet that decision hinges on what happens with jobs, consumer spending and wages. The job market has grown for 30 months straight. Americans, with more in the bank than before the pandemic, are still spending, and wages have grown faster than inflation for four straight months. Rent prices, too, have finally started to fall from pandemic highs.
The momentum prompted economists and major banks to pare back forecasts for a recession, driving major stock indexes upward.
But that fate isn’t sealed, especially since the Fed has made clear it will get inflation to normal levels at any cost. Consumer demand — for cars, travel, even movie tickets — has stayed much stronger than economists anticipated, which may make it harder to slow the economy without pain.
Crucially, the Fed is not yet seeing enough progress on a key type of inflation that has shown little response to rate hikes. That measure of inflation — which strips out volatile categories like food and energy, plus housing stems largely from wage pressures and mismatches in the labor market, including in service industries that have struggled to find workers.
“We see only the earliest signs of disinflation there,” Fed Chair Jerome H. Powell said after the central bank’s last meeting in June. “It’s a very broad and diverse sector. I would say (that,) in a number of the parts of that sector, the largest cost would be wage cost. It’s the service sector, so it’s heavily labor intensive.”
No one knows for certain when that kind of inflation will budge.
Employers are still hiring, seemingly undeterred by high borrowing costs that make it more expensive to grow their businesses.
The Fed has argued that higher rates could slow the labor market by culling vacant job openings. But there are still far more job openings than the number of people looking for work.