`We’re going to have to keep at it': Parsing Powell's words on Fed move

The Federal Reserve on Wednesday held off on raising interest rates for the first time in more than a year — but warned that at least two more increases could be in store for 2023.

Central bank officials now expect the economy to grow faster and unemployment to drop less this year than they projected in March, convincing them that higher borrowing costs might still be necessary to bring inflation back down over the next couple of years.

But they want more time to gauge the economy’s trajectory following 14 months of the most aggressive rate hikes in more than four decades.

“We have covered a lot of ground, and the full effects of our tightening have yet to be felt,” Fed Chair Jerome Powell said in his press conference after two days of central bank meetings.

The Fed’s path going forward on interest rates could have a profound impact on the 2024 elections since high borrowing costs can slow growth and dent consumer confidence, further souring Americans’ view of President Joe Biden's handling of the economy.

The forecasts from Fed officials convey a striking theme: They expect the economy to be remarkably resilient — a double-edged sword for Biden. Avoiding recession would be a boon to the White House heading into the election, but the economy's strength could also make the central bank squeeze borrowing costs even more to hit the job market harder — which could lead to a deeper downturn.

According to Fed policymakers’ projections, the unemployment rate, which currently stands at 3.7 percent, would rise to only 4.1 percent in 2023 even if rates go higher, compared to their 4.5 percent forecast in March. They also project GDP will grow 1 percent this year, suggesting that the U.S. could avoid recession. But that’s essentially their best-case scenario.

The forecasts also show considerable disagreement within the Fed about the policy direction. Half of the rate-setting committee's 18 members expect two more rate hikes this year. But six expect fewer than that, including two forecasting none at all, and three expect more. That divide reflects not only different approaches to policy but also the lack of clarity about how quickly the economy will slow.

Let’s parse what more Powell had to say.

“Given how far we have come, it may make sense for rates to move higher but at a more moderate pace.”

Here Powell is explaining one reason why the Fed is holding rates steady if it's potentially going to raise rates again later. Why wait? His response is basically that the central bank is getting closer to where it needs to stop, so hiking less often makes more sense as it gauges how the policy is feeding through to the economy. Often higher rates can take a while to fully impact hit growth, spending and, ultimately, inflation.

“Not a single person on the committee wrote down a rate cut this year, nor do I think it is at all likely to be appropriate if you think about it. Inflation … has not so far reacted much to our existing rate hikes, so we’re going to have to keep at it.”

Even if Fed policymakers don't expect to raise rates too much higher, they’re certainly not going to be lowering them. That’s his message here. The longer rates stay high, the more they affect spending and investment decisions by businesses and households, and inflation needs to drop much more before the Fed feels comfortable loosening its grip.

There’s a side message buried in here, which is that inflation has dropped for a lot of reasons that aren’t related to anything the Fed has done. He didn’t specify what he meant, but supply chain snarls have eased considerably, and there’s no longer trillions of dollars in Covid aid boosting household spending.

“Core PCE inflation is running at 4.5 percent, a little higher. And the median [Fed official] thinks it will go down to 3.9 by the end of this year. That’s expecting pretty substantial progress. That’s a pretty significant decline for half the year.”

Inflation has dropped markedly in the past year, but so-called core inflation has cooled less than food and energy, where prices are more volatile. But Powell is saying that Fed officials are generally optimistic that those prices will cool as well (he cites the personal consumption expenditure index, which is the Fed’s preferred inflation measure).

According to the Fed’s forecast, officials expect overall PCE inflation (including food and energy) to drop to 3.2 percent by the end of this year and hope to return all the way to 2 percent by 2025.

“We always write down at these meetings what we think the appropriate terminal rate will be at the end of this year. … It’s based on our own individual assessments of what the most likely path of the economy is. It can actually in reality wind up being lower or higher. And there’s really no way to know.”

This one is a pretty standard Fed disclaimer: policymakers themselves aren’t totally confident of how many rate hikes they’ll have to do this year. It depends on how the economy progresses. So two more hikes are not set.

“There is a path to getting inflation back down to 2 percent without having to see the kind of sharp downturn and large losses of employment that we’ve seen in so many past instances. It’s possible. In a way, a strong labor market that gradually cools could aid that along. But … the committee is completely unified in the need to get inflation down to 2 percent and will do whatever it takes to get it down to 2 percent over time.”

He starts out with a happy message and ends with a warning: We could end up with a soft landing — slower growth but no deep recession. Certainly, that’s what Fed officials are now projecting. But they’re willing to have a recession if that’s what it takes to restore price stability.

Sam Sutton and Katy O'Donnell contributed to this report.