US Interest Rate Predictions Shift as Inflation Stays High and Labor Market Remains Tight

Inflation Worries and Hawkish Views: Perspectives on the Future of Interest Rates

The Federal Reserve officials have expressed uncertainty about the need to further increase interest rates due to increased economic risks. The May FOMC minutes confirmed that the US central bank is considering pausing its aggressive monetary tightening campaign as it assesses how much more it needs to squeeze the economy to control inflation. The quarter-point increase in May lifted the federal funds rate to a target range of 5-5.25%, the highest since 2007.

The May meeting took place against the backdrop of a political standoff between the Biden administration and Republicans in Congress over raising the U.S. debt limit, a step which, if not taken, could lead the country to default on payments to bondholders. Fed officials noted these risks in the May minutes. Failure by Congress to raise the debt ceiling before the government ran out of cash could lead to significant disruptions to the financial system and could push rates higher, and even if any defaults are quickly resolved, there are still negative impacts. The US dollar has strengthened reaching a six-month high against the yen, on expectations that US rates may have to rise to over 6% for inflation to return to the Federal Reserve's 2% target.

The May minutes showed differences among committee members over further rate increases. Many participants stressed the need for the Fed to retain optionality after this meeting, with some believing further action would be warranted if inflation continued to decelerate slowly. A number of policymakers appear to agree that the data did not show enough of a decline in inflation to hit pause.

Fed Governor and vice chair nominee Philip Jefferson said that while progress on inflation is slowing, it is still too early for the full impact of rapid rate increases to be felt. Fed Chair Jay Powell has also expressed concerns regarding the delayed consequences of previous tightening measures as well. Powell hinted that he supports forgoing another rate rise in June.

James Bullard, the president of the Federal Reserve Bank of St Louis, has reiterated his support for raising interest rates as a safeguard against inflation. Bullard said that his main concern is that inflation doesn't go down or even turns around and goes higher, as it did in the 1970s. According to his calculations, a policy rate just above 6% represents the top end of the range.

Dallas Federal Reserve Bank President Lorie Logan also believes that US inflation is not cooling fast enough to allow the Fed to pause its interest-rate hike campaign. This view has gained ground ahead of the Fed's next meeting on June 13-14th. While the remarks represent a minority hawkish view at the Fed, they suggest that a pause in rate hikes may not be forthcoming.

John Williams, president of the New York Fed, warned that despite the coronavirus pandemic and the recent surge of inflation, central banks were most likely to have to grapple with low interest rates once the shocks pass. He referred to a level of rates that neither stimulates nor restrains growth, stating that there is no evidence that the era of very low natural rates of interest has ended.

Data since the last meeting showed a continued strong job market and little progress on the inflation front, even as risks from ongoing banking sector stress and a possible US debit limit crisis argue for caution. Unemployment is at its lowest rate since 1969 with the rise in unemployment claims currently being considered as fraud. Tom Barkin, president of the Richmond Fed, stated that at best the labor market had moved from red hot to hot.

Overall, policymakers said ensuring inflation returns to the Fed's 2% annual target remains the top priority. This would be the 11th successive increase since last year, bringing the benchmark federal funds rate to a new target range of 5.25-5.50%. Regardless of the data, the Fed is unlikely to raise interest rates if a down-to-the-wire political standoff over the US federal debt ceiling remains unresolved.

For more analysis on these topics, check out these articles:

1. Fed agreed need for more rate hikes after May meeting was 'less certain'

2. Fed officials expect interest rates to remain high, possibly rise

3. Investors bet Fed will keep interest rates higher for longer

4. Fed's Powell says risks more balanced, June policy decision unclear

5. Fed's hawks make a pitch against a rate-hike pause

6. Jay Powell says rates may not need to rise as much due to bank stress

7. Fed officials were less certain about need for more interest rate rises

8. Are Investors Underestimating Probability of Even Higher Rates?

9. Feds Bullard suggests higher rates as insurance against inflatio

10. Several Federal Reserve Officials Mull 11th Round of Rate Hikes

11. Dollar Strengthens Broadly on Fed Rate Expectations

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