The Federal Reserve is anticipated to keep its key interest rate unchanged amid economic challenges driven by surging interest rates, international turmoil, and nervous investors. Although the U.S. economy displayed resilience with robust growth and uncomfortably high inflation, the Fed remains cautious.
Chair Jerome Powell aims to ensure that the economy cools and that inflation returns to the Fed’s 2% target before signaling any deviation from the central bank’s efforts to combat rising inflation. Turbulent financial markets have caused long-term U.S. Treasury rates to rise, leading to lower stock prices and increased corporate borrowing costs. The Fed believes that these trends may contribute to an economic slowdown, thus easing inflation pressures, without requiring further rate hikes.
The Fed has raised its benchmark rate from near zero to approximately 5.4% since March 2022 to curb inflation. While this has caused an increase in mortgage, auto loan, and credit card rates, annual inflation, as measured by the consumer price index, has decreased from a peak of 9.1% in June of the previous year to 3.7%.
Economists from Wall Street banks have estimated that recent losses in the stock and bond markets may have an economic impact similar to three or four quarter-point rate hikes by the Fed. Despite the Fed’s last rate hike in July, the yield on the 10-year Treasury note has continued to rise, reaching a 16-year high of 5%. Consequently, the average 30-year fixed mortgage rate surged to nearly 8%, raising costs for credit cards, auto loans, and various forms of business borrowing.
The surge in Treasury yields can be attributed to multiple factors, including anticipated government bond sales to cover significant budget deficits and the Fed’s reduction of bond holdings. Consequently, Treasury rates may remain high to attract more buyers.
The critical concern for the Fed is that the 10-year Treasury yield has risen significantly without requiring central bank rate hikes. This indicates that Treasury yields may stay elevated even with the Fed’s benchmark rate unchanged, impacting business and consumer loan rates, and subsequently, economic growth and inflation.
Market analysts predict a 98% likelihood that the Fed will maintain interest rates on Wednesday, with a mere 24% probability of a rate hike at the following December meeting. The Fed aspires to achieve a “soft landing,” effectively slowing inflation to 2% without causing a deep recession.
Inflation’s decline from its peak, coupled with strong employment, robust consumer spending, and solid economic growth, defies traditional economic models that suggest a recession is necessary to combat inflation. The pandemic’s influence has upended these traditional relationships, leaving the Fed with less predictable guidance for policy decisions.
The Fed is navigating uncharted territory with the economic landscape altered by COVID-19, making traditional models like the Phillips Curve less applicable in assessing inflation trends. While the challenge is significant, the Fed remains committed to maintaining price stability and fostering sustainable economic growth amid this complex environment.