Inflation has slowed. Now the Federal Reserve faces expectations for rate cuts

WASHINGTON — Chair Jerome Powell will enter this week’s Federal Reserve meeting in a much more desirable position than he likely ever expected: Inflation is getting close to the Fed’s target rate, the economy is still growing at a healthy pace, consumers keep spending and the unemployment rate is near a half-century low.

A year ago, most economists had envisioned a much darker outlook. As the Fed raised interest rates at the fastest pace in four decades to fight high inflation, most economists warned of a recession, possibly a painful one, with waves of layoffs and rising unemployment. Even the Fed’s own economists had projected that the economy would sink into a recession in 2023.

The unexpectedly rosy picture — one that’s sure to be subject to heated debate in the 2024 presidential race — may have left some Fed officials saddled by uncertainty. With their frameworks for assessing the economy upended by the pandemic and its aftermath, it’s hard to know whether the economy’s healthy conditions can endure.

“It almost feels like what we saw in the second half of last year was too good to be true,” said Nathan Sheets, chief global economist at Citi and a former Fed economist. “When things are too good to be true, you want to try to scratch the surface and say, how durable is this?”

Some Fed officials have raised similar questions and expressed caution about their next moves. When they last met in December, the Fed’s 19 policymakers who participate in interest-rate decisions said they expected to cut their benchmark rate three times this year. Yet the timing of those rate cuts, which would lead to lower borrowing costs for consumers and businesses, remains uncertain.

Most economists say they expect the first rate cut to occur in May or June, though a cut at the Fed’s March meeting is not off the table. The timing of rate cuts will almost certainly be the top issue at the Fed’s two-day meeting, which ends Wednesday. The Fed is all but sure to announce after the meeting that it’s leaving its key rate unchanged at about 5.4%, where it’s stood since July, its highest point in 22 years.

The Fed’s consideration of rate cuts is taking place against an intensifying presidential campaign as President Joe Biden seeks re-election with the economy a polarizing issue. Rate cuts have the potential to provoke an attack from former President Donald Trump, who nominated Powell to be Fed chair but later publicly assailed him for raising rates during the Trump presidency and demanded that he lower them. Trump might view any Fed rate cuts carried out this year as aiding Biden’s prospects in November.

At a news conference last month, Powell said: “We don’t think about politics. We think about what’s the right thing to do for the economy.”

On Wednesday, the Fed’s policymakers could signal that they’re close to cutting rates by adjusting the language in the statement they issue after each meeting. In December, the statement still suggested that the officials were willing to consider more rate increases. Removing or altering that language in this week’s statement would signal that they’re shifting to a new approach, focused on rate cuts.

The Fed’s aggressive streak of 11 rate hikes, beginning in March 2022, was intended to tame inflation, which peaked in June 2022 — according to the central bank’s preferred gauge — at 7.1%. But data released Friday showed that over the past six months, inflation has fallen all the way back to the Fed’s 2% annual target level. In the past three months, year-over-over inflation that excludes volatile food and energy costs has dropped to just 1.5%.

Yet Fed officials are expected to wait for at least a few months, to try to build confidence that inflation has been truly beaten, before they start reducing rates.

Christopher Waller, an influential member of the Fed’s governing board, sounded a note of caution in a recent speech.

“Inflation of 2% is our goal,” he said. “But that goal cannot be achieved for just a moment in time.”

Waller has previously referred to having been “head-faked” on inflation. On more than one occasion, when initial government reports had indicated that inflation was falling, subsequent revisions to the data showed that price increases actually remained high. In his speech, Waller mentioned the government’s upcoming revisions of inflation data, to be released on Feb. 9, as a report he will be watching closely.

Average paychecks are still increasing at about 4% to 4.5% annually, and apartment rental prices are still rising faster than they did before the pandemic.

Officials expect rent prices to cool as a slew of new apartment buildings are completed. But that has yet to show up in the official data. And some prices in the service sector, such as for restaurant meals, are still accelerating.

“We would argue we’re not out of the woods yet,” said Tiffany Wilding, a managing director and economist at PIMCO.