Expectations are building for another supersized interest rate increase when the Federal Reserve convenes later this month, as central bankers underscore their commitment to controlling inflation — even at the risk of slowing the economy too aggressively and causing a recession.
Powell’s remarks were just the latest example of the Fed’s increasingly direct message: The central bank will not stop hiking rates until inflation is under control, no matter what the other consequences are. Powell said the “clock is ticking” to keep inflation expectations in check. Just a day before, Fed Vice Chair Lael Brainard said “we are in this for as long as it takes to get inflation down.”
The pointed tone comes as the Fed is trying not just to control inflation but also to cement credibility with financial markets and American people that it will fix the economy’s biggest problem. The Fed misread warnings last year that inflation was spreading deeper into the economy, and officials have since been in a rush to slow an economy that quickly overheated.
Fed leaders haven’t suggested they’re ready to bring down the pace or scale of their rate hikes yet, and markets are increasingly pricing in another rise of three-quarters of a percentage point at the Sept. 20-21 policy meeting, mirroring the hike in July. Goldman Sachs on Wednesday revised its own forecasts to include a three-quarter-point hike in September, up from expectations for a half a percentage point.
“What I’ve observed from ‘Fed speak’ this week … can be summed up in one word: resolve,” said Joe Brusuelas, chief economist at RSM. “I think there is ample reason why markets are moving to price that in.”
The Fed’s tools to ease inflation’s burden on households and businesses are blunt, revolving around interest rate increases that make lending and investment more expensive. The goal is to cool demand in the economy, especially since the bank can’t do anything to address supply chain problems, Russia’s invasion of Ukraine or other global factors keeping prices high.
Inflation eased a bit in July, thanks to falling gas and energy prices. But officials say they will need months of consistent data to know if their hikes are working. Next week, the Bureau of Labor Statistics will release new inflation data from August.
“Monetary policy will need to be restrictive for some time to provide confidence that inflation is moving down to target,” Brainard said Wednesday in a speech before the Clearing House and Bank Policy Institute’s Annual Conference. “The economic environment is highly uncertain, and the path of policy will be data dependent.”
That uncertainty is global. On Thursday, the European Central Bank raised interest rates for the second time this year, hiking those levels by three-quarters of a percentage point to fight inflation. Officials warned that they expect to continue raising rates over the next few months, all while facing the prospect of a severe energy crisis in Europe this winter.
The Fed has raised rates four times this year and is expected to raise rates at the remaining meetings in September, November and December. Fed officials acknowledge that they don’t know how high rates have to go or how fast to raise them, especially since hikes operate with a lag and will slow economic activity much more later this year or early next year.
“At some point in the tightening cycle, the risks will become more two-sided,” Brainard said, noting that while there are plenty of unknowns, it is also “important to avoid the risk of pulling back too soon.”
Already, the U.S. economy shrank in the first two quarters of 2022, raising fears of a recession and suggesting the economy is already cooling markedly, even while inflation remains high. The slowdown is most evident in sectors that are especially sensitive to interest rates, namely the housing market. Over the past few months, the Fed’s moves triggered a run-up in mortgage rates, culling the buyer pool and putting a damper on the competitive bidding wars and soaring price growth that defined much of the pandemic.
In much of the country, the number of homes listed for sale during the pandemic was low enough that inventory would run out in a matter of weeks if demand stayed constant. Now supply is closer to 11 months. Research from KPMG shows new-homes sales plummeted 12.6 percent in July from the month before, and mortgage applications to purchase a home reached their lowest level since 2016 (excluding the first few weeks of the 2020 pandemic-driven recession).
Housing is often a leading indicator for where the rest of the economy will go, and economists and housing officials are closely tracking it for signs of a more worrisome downturn or a broader recession. But so far, higher rates seem to be having the intended effect of slowing a sector that was churning at unsustainable levels, without causing it to crash altogether, at least so far.
“Home prices are holding steady,” said Brian Bullock, vice president of sales and marketing for Homes by WestBay, a home builder in Tampa. “Overpriced homes are the ones that aren’t selling. … You don’t have the surge of demand from before, where you’d be paying over a rational price for a home.”
Even as some parts of the economy pull back, others are keeping up momentum. Crucially, the job market is still churning and added 315,000 jobs in August alone. A Fed survey known as the “beige book” released Wednesday showed that consumer spending remains strong, even as households grappled with the toll of inflation.
But rates that escalate, and escalate fast, could undermine those bright spots. Speaking to the Financial Times on Tuesday, Richmond Fed President Tom Barkin said he prefers “moving more quickly, rather than more slowly” on raising rates, “as long as you don’t inadvertently break something along the way.”