The Federal Reserve left its overnight lending rate unchanged yet again at its meeting this week, its seventh consecutive meeting of doing so. The decision maintains the overnight lending target rate for banks to between 5.25% and 5.5%, a 22-year high.
The decision was issued on the heels of the latest inflation report from the Commerce Department showing price increases cooling in May. The headline consumer price index remained unchanged over the month, and the core price index, which excludes food and energy, rose by just 0.2% in the month, less than many had forecasted. Inflation accelerated in the first three months of the year, worrying investors that rate cuts might be further delayed as the Fed keeps its monetary policy restrictive to battle rising prices.
The last time the committee changed its target rate was its final hike at its July 2023 meeting.
The policymaking committee’s statement issued at the end of its two-day meeting noted that economic activity has continued to grow “at a solid pace” and “job gains have remained strong.”
The Commerce Department recently downgraded its estimate of economic growth in the first quarter from 1.6% to 1.3% at an annualized rate, a meaningful slowdown from 3.3% in the fourth quarter of last year, which followed a 4.9% annualized gain in the third quarter. That strong economic growth led the Fed to signal that it would hold off on rate cuts for a while. The latest inflation print offered some relief on that front.
On the inflation data release, markets were buoyed by the prospect of rate cuts beginning in the third quarter. According to the FedWatch Tool from the financial services firm CME Group traders priced the probability of rate cuts beginning in September at more than 80%. Most were expecting two rate cuts this year.
Committee members appear more circumspect. In their updated Summary of Economic Projections, the median prediction of the 19 committee members suggested total cuts of 25 basis points in 2024, or just a single cut, compared to the 75 basis points in cuts the group expected in its May forecast. Four committee members suggest no rate cuts in 2024 at all, and one suggests no rate cuts in 2025. The remaining projections on the policy rate indicate ending 2025 at 4.1% before falling to 3.1% in 2026, or 100 basis-point cuts in both years, a faster decline than predicted in March.
When asked at his post-meeting press conference about the slowing of rate cuts compared to earlier projections, Fed Chairman Jerome Powell pointed to accelerating inflation reports earlier in the year, noting the recognition among committee members that “it’s probably going to take longer to get the confidence that we need to begin loosening policy.”
As Powell continued to speak, markets began shifting expectations for the first and likely only rate cut to occur in November, reaching a 99% probability as the press conference ended.
The CPI report buoyed markets and prompted some relief after months of less encouraging news. The headline and core price indices rose on more robust consumer spending in the first three months of the year before pulling back in April, a welcome turn.
The so-called supercore CPI index, representing core services less housing, dropped by 0.04% in May, its first fall since 2021. This segment of the economy is more labor-intensive. Hence, the Federal Reserve closely monitors the labor market and wage growth to anticipate a possible wage-price spiral.
Monthly job gains have broadly been moderating since mid-2021 but have seen large monthly gains from time to time. In May, 272,000 positions were added, boosting the three-month moving average to 249,000, more than the five-year pre-pandemic average. Wage growth has been solid and running faster than inflation for more than a year, improving consumers’ purchasing power and fueling household spending.
However, evidence of some weakness in the labor market is emerging. The unemployment rate ticked higher to 4.0%, the first time it has reached that rate since January 2022. Moreover, according to the latest report, job openings fell to 8.1 million, the lowest number since February 2021. This brings the number of openings for each unemployed worker to 1.2, similar to the pre-pandemic ratio.
Compared to the committee’s projections released in March, the median view of economic growth for 2024, 2025 and 2026 were unchanged, at 2.1%, 2.0% and 2.0%, respectively. Inflation, as measured by the core personal consumption expenditures price index, is expected to be 2.8% in 2024, a continued acceleration over the March forecast of 2.6%, before falling to 2.3% in 2025 and 2.0% in 2026. The median view of the unemployment rate in 2024 was unchanged at 4.0% but was revised ten basis points higher in both 2025 and 2026, to 4.2% and 4.1%, respectively, as the economy slows.
The Fed’s pause to cut rates stands in contrast to recent actions taken by other central banks. The European Central Bank cut its key interest rate last week by 25 basis points. However, economic growth there has been much slower than in the United States, sitting at or near zero since the end of 2022, suggesting the need for a boost. The Bank of Canada also reduced its target rate as its labor market continues to weaken, while the strength of the U.S. labor market is allowing the Federal Reserve to keep policy restrictive in its continued effort to bring inflation closer to its target. Switzerland, Sweden, Hungary and the Czech Republic have all lowered rates this year.