The Editorial Board
Bloomberg
May 16, 2024
As the Federal Reserve struggles to make sense of a ceaseless flow of noisy statistics, it needs to keep one question front of mind: Is the current policy rate restrictive enough to bring inflation gently back down to the central bank’s 2% target? Right now, taken as a whole, the evidence says yes.
Financial markets have been wondering. Prices and wages rose faster than expected in the first quarter, suggesting that inflation might flatten out at higher than 3%. If that turned out to be true, it would reveal that the current policy rate of 5.25% to 5.5% (a 23-year high) is too low and that the next change in interest rates would need to be upward. Asked about this at an event on Tuesday, Fed Chair Jerome Powell wouldn’t rule out the need for higher rates, but he urged patience. “It looks like it will take longer for us to become confident that inflation is coming down to 2% over time,” he said.
Good call. Despite slower-than-expected progress, the latest figures suggest inflation is indeed edging lower. The core consumer price index rose 0.3% in April, down from 0.4% in each of the previous three months. The labor market is calmer: In April, employers added 175,000 jobs (less than in previous months) and the unemployment rate rose to 3.9% (still low by pre-pandemic standards, but a sign of cooling nonetheless). The difference between a temporary rise in inflation and one that gets firmly embedded is wages — and wage growth is moderating. April’s rise of 2.8% in hourly earnings over three months (at an annual rate) is consistent with target inflation and trend growth in productivity.
This evidence of continuing disinflation is well-timed. Having previously signaled rate cuts in the second half of this year, the last thing the Fed wants between now and November’s elections is to court political controversy by reversing itself and raising rates. Investors understand that this context adds to the risk that policy might stay too loose for too long. Fortunately, the data supports the Fed’s position that it can afford to wait and see, and that its choice will be when to start cutting, not whether to raise rates further.
Powell and his colleagues need to stay open-minded. Forthcoming data is bound to send mixed messages. Lags and base effects could well nudge some inflation numbers temporarily higher over the coming months. Shelter costs, for instance, take a while to show up in the figures. The recent surge in immigration is another complication: In due course, it will expand the supply of goods and services (which is disinflationary), but in the short term, it also adds to net demand (pushing prices higher).
The underlying picture is always hard to read. Sudden swerves in policy might need to be just as quickly reversed: That’s why they’re best avoided. For the moment, the economy is growing, unemployment is low, demand is moderating and inflation, though still too high, is slowly coming under control. Until further notice, there’s no need for the Fed to pivot.