The policy decision to come this week has been unambiguously telegraphed by US central bankers, as they are expected to deliver the smallest hike in the tightening cycle that started 10 months ago of the same size.
The Federal Reserve is scheduled to meet this week on February 1st and will deliver an interest rate hike of 25 basis points.
Lack of clarity
The real lack of clarity is about whether the Fed will signal ‘ongoing increases’ in the policy rate ahead because there is mounting evidence that the economy as well as inflation are slowing down.
Since March 2022, this particular phrase has been included by the Federal Reserve in every policy statement.
That was when officials had started hiking interest rates from close to zero and had wanted to clarify that there would be more tightening in the future.
The meeting of the Federal Open Market Committee (FOMC) will start on January 31st and conclude on February 1st and the rate increase expected from it would see the rate reach 4.5% and 4.75%.
This is short of two quarter point rate increases of the level that most Fed policymakers had said would be enough for bringing inflation under control back in December.
Market analysts said that it was unclear if the term ‘ongoing’ would refer to two more interest rate hikes.
But, they added that the Fed would be cautious about doing something that could make markets believe that they were hitting a pause on the interest rates soon.
This is precisely what seems to have been priced in by financial markets. They show that rate hikes would end in March when the target rate would be between 4.75% and 5%.
They further indicate that rate cuts would begin happening from September, as economists have forecast a reduction in inflation and an economic recession.
As of December, Fed policymakers do not see rate cuts happening until 2024. Analysts said that if they hint to the market that rate hikes are over, it would imply that rate cuts would be next.
This could result in more inflation because it would ease the financial conditions that the central bank has tried to tighten.
However, it is apparent that the aggressive monetary policy tightening from the Fed, which saw rate hikes of 75 basis points delivered, has come to an end.
Instead, they have shifted to something more gradual, but there is still uncertainty about how much more the Fed will tighten.
This is because inflation is gradually declining. In December, there was a 4.4% increase in the personal consumer price index that the Fed focuses on for gauging inflation.
But, it still remains higher than the 2% inflation target. It also seems that US consumers have now registered the aggressive response of the Fed.
This is because they have begun to consider high inflation a lasting phenomenon, which is a concerning development because it had led to big rate hikes.