Why the Federal Reserve Won't Commit

Mark Carney, the former Bank of England governor, was once labeled the United Kingdom's ' unreliable boyfriend ' because his institution had left markets confused about its intentions. Jerome H. Powell's Federal Reserve circa 2023 could be accused of a related rap: fear of commitment.

The Fed, headed by Powell, is raising interest rates to slow down the economy and control rapid inflation. Investors and households are trying to predict what the central bank will do over the next few months in a chaotic economic time. Recent signs of growth have shown that the economy is showing strength, after it was slowing down.

Powell and his coworkers have not been clear about their plans. Although they haven't shown much interest in speeding up rates again, they haven't completely ruled out the possibility. They have not provided any clear criteria as to when the Fed will know that it has raised interest rates sufficiently high. They have not stated that rates should be kept high for a while, but they are unsure of what factors will determine how long.

The Fed's shrewd ways are not easy to understand, as is anyone who doesn't want to be defined. The central bankers are keen to remain flexible in an uncertain time for the American economy.

Image

Fed officials got burned in 2021. They communicated firm plans to leave interest rates low to bolster the economy for a long time, only to have the world change with the onset of rapid and wholly unexpected inflation. Policymakers couldn't rapidly reverse course without causing upheaval — breakups take time, in monetary policy as in life. Thanks to the delay, the Fed spent 2022 racing to catch up with its new reality.

This year, policymakers are retaining room to maneuver. That has become especially important in recent weeks, as strong consumer spending and inflation data have surprised economists and created a big, unanswered question: Is the pickup a blip being caused by unusually mild winter weather that has encouraged activities like shopping and construction, or is the economy reaccelerating in a way that will force the Fed to react?

Mr. Powell will have a chance to explain how the central bank is thinking about the latest data, and how it might respond, when he testifies on Tuesday before the Senate Banking Committee and on Wednesday before the House Financial Services Committee. But while he will most likely face questions on the speed and scope of the Fed's future policy changes, economists think he is unlikely to clearly commit to any one path.

'The Fed is very much in data-dependent mode,' said Subadra Rajappa, the head of U.S. rates strategy at Société Générale. 'We really don't have a lot of clarity on the inflation dynamics.'

Data dependence is a common central bank practice at fraught economic moments: Officials move carefully on a meeting-by-meeting basis to avoid making a mistake, like raising rates by more than is necessary and precipitating a painful recession. It's the approach the Bank of England was embracing in 2014 when a member of Parliament likened it to a fickle date, 'one day hot, one day cold.'

The Fed isn't even sure which data will be most important in deciding its future policy. When discussing their outlook, officials cite a variety of data on inflation, consumption and wages.

Mr. Powell is likely to stick to that open-ended script this week — but markets will still watch him closely for any clearer signal about what comes next.

Policymakers have recently slowed the pace of rate increases, making a quarter-point move in February after months of larger adjustments. Many Fed officials have implied that they will stick to quarter-point moves going forward, focusing on how high rates will ultimately go rather than how quickly they will get there.

Image

However, the possibility of the Fed making larger moves this month is still possible. Neel Kashkari (the president of the Federal Reserve bank of Minneapolis) stated that he was open-minded and expected to make a quarter-point- or half-point move at the Fed's meeting this month.

In a preview, Krishna Guha, an economist at Evercore ISI wrote that Powell won't likely 'fuel speculation' about a larger, half-point move. However, he will 'not exclude' the possibility of another bigger move in future.

Fed watchers will be looking out for signs about the direction of interest rates. Although central bankers suggested that recent inflation and hiring numbers could cause officials to raise borrowing costs beyond the 5 percent to 5.25% range they predicted in December's economic projections, they have not yet confirmed this.

Mr. Powell may hint that higher rates are becoming more likely, economists think, but he's unlikely to firmly forecast a specific number.

'We're living in a world of significant uncertainty,' Mr. Powell said at his last news conference, in early February. 'We're trying to make a fine judgment about how much is restrictive enough.'

Making that 'fine judgment' has gotten more complicated in recent weeks.

Policymakers have raised rates aggressively over the past year, to above 4.5 percent from near zero a year ago. Fed officials thought that lifting rates so high would slow growth — and that they would soon be able to stop increasing borrowing costs.

A cool-down did seem to be taking hold toward the end of 2022. Inflation was slowing with each passing month, consumers were pulling back and hiring had moderated gradually but notably.

But the start of 2023 threw a wrench in the narrative. Employers added more than half a million workers in January, inflation has shown signs of firming and consumer spending has come in strong across an array of measures.

Image

That has raised a question: Is the Fed's policy rate high enough to meaningfully restrain an economy with this much momentum? And it has left central bankers watching carefully to see whether the strength will reverse.

'It's hard to talk about policy as restrictive — or sufficiently restrictive — when the forward momentum in the economy is so strong,' said Neil Dutta, an economist at Renaissance Macro. 'And, more important, inflation hasn't been resolved at all.'

Wall Street bets range widely when it comes to where the federal funds rate will be at the end of the year. Investors are penciling in anything from 4.5 percent to above 6 percent.

Economists at Goldman Sachs wrote in a note this week that if consumption continued to pick up, rates might need to rise to a range of 5.75 percent to 6 percent in order to slow the economy enough to bring inflation under control.

Central bankers have time to stay vague ahead of their meeting on March 21-22, and good reason to do so: Officials will receive a fresh reading on labor conditions on March 10 and fresh consumer price inflation data on March 14.

Those could shift the economic narrative somewhat.

'I would be very pleased if the data we receive on inflation and the labor market this month show signs of moderation,' Christopher Waller, a Fed governor, said in a recent speech, adding that he was looking for signs that the latest figures 'were just a bump in the road.'

Still, he warned that 'wishful thinking is not a substitute for hard evidence.'

And the Fed's window to watch, wait and retain wiggle room is narrowing. Policymakers are scheduled to put out a fresh set of quarterly economic projections alongside their rate decision on March 22.

Those will show how high they expect interest rates to move in 2023 — illustrating whether they think rate moves will stop after May, the endpoint implied by their latest projections.