Traders react as Federal Reserve Chair Jerome Powell is seen delivering remarks on a screen, on the floor of the New York Stock Exchange in New York City on May 3.BRENDAN MCDERMID/Reuters
The U.S. Federal Reserve announced a significant downshift in its interest rate tightening campaign Wednesday. But it’s hard to figure out just how to describe it.
It didn’t stop raising rates. In fact, it raised by another quarter of a percentage point, to a range of 5 to 5.25 per cent, extending this tightening phase to nearly 14 months and five full percentage points.
It didn’t say it would put interest rates on hold from here. It didn’t even quite declare a “conditional pause,” along the lines that the Bank of Canada did in January.
Maybe what the Fed has declared is a conditional conditional pause. There are no promises, or even promises of promises. But the U.S. central bank has opened a window, just a crack, through which the sweet scent of a rate pause has drifted in. Even if the Fed is still reluctant to breathe that fresh air.
In the universe in which central bank policy statements exist, very small changes of wording and phrasing can have very large implications. Wednesday’s rate-decision statement was a textbook example of how a few words can simultaneously redraw and blur the lines around a policy stance.
A pivotal phrase contained in the Fed’s previous statement in March – “The committee anticipates that some additional policy firming may be appropriate” – is now gone. The Fed now it says it will consider “the extent to which additional policy firming may be appropriate.”
It’s absolutely a downgrade in the Fed’s rating of the likelihood of further rate increases. Still, when you go from “we think we might still need further hikes” to “we’re going to think about how much more we need to hike,” it’s a pretty subtle shift. Even for the seasoned central banking reporters at Fed chair Jay Powell’s post-announcement news conference, it was difficult to grasp just how much of a change this wording represented.
“A decision on a pause was not made today,” Mr. Powell stated emphatically. But in the next breath, he directed reporters to that specific rephrased passage in the announcement, calling it “a meaningful change.”
“We’ll be driven by incoming data, meeting by meeting,” to determine where rates go from here, he said.
Later, when asked if it’s possible that interest rates have, in fact, already been raised high enough to bring inflation down to the Fed’s 2-per-cent target, Mr. Powell suggested that, yes, maybe they have.
“We may not be far off, or possibly [we’re] even at, that level,” he said.
But Mr. Powell, despite being the head of the U.S. central bank, only has one of 11 votes on its policy-setting Federal Open Market Committee. Given that the wording of the rate-decision statement isn’t nearly as hopeful as Mr. Powell sounded at times in his news conference, we can assume that others at the table are keen on, at very least, hedging their bets and waiting for a few more weeks of data. Then they can let us know if Wednesday’s somewhat cryptic signal really was a pause, or a glimmer of false hope.
A great deal of what Mr. Powell and his Fed colleagues communicated Wednesday is strikingly similar to what the Bank of Canada started saying more than three months ago, when it became the world’s first major central bank to signal that it planned to halt rate increases.
The decision would depend on an “accumulation” of economic data; inflation is still too high, and higher rates might ultimately still be needed; the inflation target of 2 per cent is still a long way off. And – critically for market participants who have continued to speculate about the potential for rate cuts by the end of this year – that 2 per cent absolutely remains the goal, and anything short of that is not enough.
“We’re not looking to get to 3 per cent and then drop our tools. We have a goal of getting to 2 per cent. We think it’s going to take some time,” Mr. Powell said. “We’re going to need to stay at this for a while.”
On the surface, at least, the Fed seems to be largely following the same course that the Bank of Canada has been charting. Given that we’ve just gone through a period of global central bank groupthink that led policy-makers astray on inflation, there’s little comfort in the remarkably common view. There is absolutely a danger of central banks overdoing it on rate hikes and inflicting serious economic damage. With the Fed now 0.50 to 0.75 percentage point above the Bank of Canada, and possibly still rising, it may be straining those limits already.
There is, however, one factor peculiar to the United States that could give the Fed a unique relief valve; indeed, it was a key impetus for the Fed’s shift on Wednesday. The strains in the U.S. banking sector have resulted in tighter credit conditions, as risk premiums have risen and lenders have become more cautious. In effect, the banking troubles are having the same effect as Fed rate hikes – higher borrowing costs and, ultimately, slower economic activity.
That, Mr. Powell acknowledged, could be the catalyst that allows the Fed to finally get off its rate-hike hamster wheel. But it’s a wild card.
“Conceptually … we won’t have to raise rates quite as high,” he said. However, he cautioned, “The extent of that is so hard to predict.”