The Federal Reserve sends mixed interest rate signals to borrowers and Biden

Author: Claire Jones, Financial Times

On Wednesday, Federal Reserve (Fed) officials delivered bad news to Joe Biden and potential homeowners—the cost of borrowing will not decline as quickly or significantly this year as the central bank had anticipated in the spring.

At least that was the message revealed in the so-called dot plot from the Federal Open Market Committee (FOMC) on Wednesday afternoon in Washington. The dot plot is a visual representation of officials' expectations for interest rates. This was somewhat unexpected.

Hours earlier, the decline shown in the May Consumer Price Index (CPI) inflation report sparked a rebound in the stock market, as investors had already priced in expectations of two 25 basis point rate cuts by the Fed before the end of the year, believing there was over an 80% chance the Fed would cut rates for the first time in mid-September (before the U.S. elections).

The dot plot indicated otherwise. Fed officials stated that price pressures remain a concern, and the Fed would only cut rates by 0.25 percentage points this year.

Worse still—for President Biden and borrowers—Fed officials raised their inflation expectations while maintaining interest rates at a 23-year high of 5.25% to 5.5%.

If this is true, it means that even if other central banks around the world begin to cut rates, the Fed's first rate cut may still be nearly six months away, after the November presidential election.

This delay could have significant implications for Biden, who is facing low approval ratings due to his handling of economic issues.

Vincent Reinhart, chief economist at Dreyfus and Mellon and a former FOMC official, stated, "If a 25 basis point cut is considered appropriate action, then it makes perfect sense to act in December. If you are waiting for greater confidence against inflation, then why not wait until the last meeting? By then, you will have all the data for 2024."

However, some are less convinced. The dot plot and market bets have also changed in recent months—officials predicted three rate cuts this year back in March. Even after Wednesday's meeting, traders still believed there was a 64% chance the Fed would cut rates in mid-September.

At the press conference following Wednesday's meeting, Fed Chair Jay Powell seemed to go to great lengths to keep things more open than the dot plot suggested, stating that officials' predictions were "very close."

"Out of 19 (predictions), 15 are clustered around one or two (cuts). I think all of that is reasonable and reliable." He added that no one had made "a really firm commitment to a specific rate path."

Some Fed watchers noted divisions within the Fed.

Krishna Guha, vice chairman of Evercore ISI, stated that he believes many of the Fed's most influential rate setters (including Powell) may support two rate cuts.

"This is a signal of 1.5 cuts." He said this means the decision at the Fed's last meeting before the election in September remains uncertain.

Powell also downplayed the significance of rate setters raising their core inflation expectations for this year (from 2.6% to 2.8%), calling it a reflection of "a slight conservative factor."

"Are we very confident that this is correct? No, it's just a conservative way of forecasting. If we get more data like today, then of course that won't be the case." He referred to the relatively weak CPI reading for May.

More "popular" inflation data, such as the May CPI figures, or signs that high borrowing costs are weakening the U.S. job market, could lead to more rate cuts than the dot plot suggested on Wednesday.

Powell also noted that the housing market is part of the inflation picture that the Fed will closely monitor, and the Fed will remain sensitive to signs of excessive distress caused by high rates.

In addition to credit card debt, high mortgage rates are particularly troublesome for young Americans trying to enter the property ladder—according to polls, this is a major source of dissatisfaction.

While the White House has been reluctant to undermine the Fed's independence or publicly call for rate cuts, Democratic Senators Elizabeth Warren and Jacky Rosen stated on Monday that high borrowing rates are driving up housing costs.

Powell said, "The best thing we can do for the housing market is to reduce inflation so that we can lower interest rates."

The resilience of the U.S. economy will continue to complicate this task.

Next month marks the anniversary of the Fed's rate hike to a 23-year high, after the Fed raised rates by 500 basis points to curb the worst inflation in a generation.

Its impact on the economy has not been as severe as some feared, and it remains unclear whether inflation will continue to decline, whether unemployment will rise enough to accelerate the Fed's rate-cutting plans, or whether it will meet Biden's hopes of timely reducing borrowing costs before the election.

On Wednesday, Powell was eager to let the data decide—leaving room for a rate cut in September.

Blerina Uruçi, chief U.S. economist at T. Rowe Price, stated, "I do think the Fed will carefully consider whether to take political factors into account. But that will be on the margins. If it is clear that (a rate cut) is what the economy needs, I don't think they will worry about the election."