Fed holds rates as it struggles with inflation’s last mile

The Federal Open Market Committee (FOMC) voted unanimously to hold the policy rate steady today (May 1), as policy-makers indicated inflation was not on track to target.

The federal funds rate stands unchanged between 5.25% and 5.5%, the peak reached in July 2023.

The Fed added a sentence to its statement on monetary policy that indicated its frustration on inflation. “In recent months, there has been a lack of further progress toward the committee’s 2% inflation objective,” it said.

Year-on-year personal consumption expenditures inflation has ticked up. The figure was 2.7% in March and 2.5% in both January and February, stoking fears that the last mile of inflation could be the toughest. Year-on-year core inflation hovered at 2.8% in both March and February, slightly lower than January’s reading.

Fed chair Jerome Powell said policy is restrictive. “And we believe over time it will be sufficiently restrictive [to reach the 2% target],” he told a press conference. But he added that the FOMC’s belief will need to be proved by incoming data.

It remains unlikely the next move will be a rate hike, Powell said.

Persistent inflation has come alongside weakening growth. US GDP took an unexpectedly large dip in the first quarter of 2024. The last quarter of 2023 saw 3.4% growth, but the first figure of 2024 came in low at 1.6%.

Joshua Aizenman, chair in economics at the University of California, says the diverging inflation and GDP figures are bad news. He tells Central Banking the Fed is in a tougher position now than would have been anticipated at the end of 2023.

“A fair share of observers hoped for a softer landing before entering the US election cycle, and there was greater optimism that the geopolitical challenges would be mitigated,” Aizenman says.

Luis Alvarado, global fixed income strategist for the Wells Fargo Investment Institute, says the situation has changed. “Late last year the Fed showed willingness to cut rates in 2024 as it was assuming the disinflationary trend would continue. To the Fed’s surprise, inflation has remained stickier than anticipated.”

He notes a big component of consumer price inflation in the US is rents, and “we are seeing a lot of pressure in this sector”. Aizenman similarly highlights the “growing scarcity of more affordable rental units and new condominiums, and growing concerns about rising costs of other services”.

However, Alvarado argues the Fed “just needs to remain on hold at current policy rate levels longer than they expected”, he says. “At this time their credibility is on the line.”

Powell said inflation could still fall while wages rise or while the labour market remains strong. Strong growth did not create problems with inflation last year, he noted.

Fed officials have mostly backed the current stance of monetary policy. One of the few to say monetary policy may not be restrictive enough was Federal Reserve Bank of Dallas  president Lorie Logan.  On April 5, she said she was “concerned that the stance of monetary policy may not be as restrictive as most forecasts assume”. 

Others are more comfortable with the current position. “I think monetary policy is working at the rates we have now,” Federal Reserve Bank of New York president John Williams told Bloomberg on April 15. He added his base case scenario still sees the Fed cutting rates this year.

Federal Reserve Bank of Richmond president Tom Barkin said that US rate-setters should be patient, in a speech on April 4. “I think it is smart for the Fed to take our time. No one wants inflation to re-emerge,” said Barkin, a voting member of the FOMC in 2024. “We have time for the clouds to clear before beginning the process of toggling rates down.” He said data suggests “the full impact of higher rates is yet to come”.

In addition to holding rates today, the Fed announced a slowdown in its quantitative tightening programme. It will now cap the maximum amount of bonds redeemed per month at $25 billion, down from $60 billion.

The Federal Reserve posted its largest operating loss ever in 2023, driven in large part by losses on assets bought under previous quantitative easing programmes. As of March 21, the Fed owed $157.8 billion through an accounting device known as a “deferred asset”. It will only resume payments to the Treasury when the deferred asset is paid off.