Fed’s faith in ‘immaculate disinflation’ narrative put to the test

The Federal Reserve will conclude a two-day policy meeting on Wednesday, with officials parsing evidence of slowing inflation alongside continued labor market strength and a jump in consumer confidence to decide when it may be appropriate to ease the U.S. central bank’s currently restrictive monetary policy stance.

Policymakers are expected to leave the Fed’s benchmark overnight interest rate in the 5.25%-5.50% range at the end of their meeting, but more importantly they will have to summarize their current views about an economy that is challenging some of the central bank’s basic assumptions.

Inflation, which soared to a 40-year peak in the middle of 2022, triggering an aggressive Fed rate hiking cycle, is slowing while the economy continues to grow at a surprising pace and the unemployment rate shows no signs of any significant rise from historically low levels.

The situation, dubbed “immaculate disinflation” by some economists, has left Fed policymakers in the position of having to decide whether to trust that such a best-of-possible-worlds result can continue and start reducing the policy rate to encourage it, or wait for more data to build confidence that inflation will continue to fall.

The policy statement is due to be released at 2 p.m. EST (1900 GMT).Fed Chair Jerome Powell will hold a press conference half an hour later to elaborate on a decision that could pose communication challenges of its own as the central bank tries to reconcile a pivot towards lower interest rates in an economy that continues to show the sort of momentum that could, all things equal, keep inflation above the Fed’s 2% target.

Yet the pace of price increases continues to slow even as the economy ended 2023 on a high note.

U.S. gross domestic product grew at a 3.3% annualized rate in the last three months of the year, well above what Fed officials consider to be the economy’s long run non-inflationary growth rate of around 1.8%.

The unemployment rate in December remained at 3.7%, while data released on Tuesday showed a sustained high level of job openings that jumped back above 9 million last month- leaving more than 1.4 open jobs for every unemployed jobseeker, well above the ratio of jobs to jobseekers seen before the COVID-19 pandemic.

Yet the Job Openings and Labor Turnover Survey (JOLTS) also showed the rate at which workers are quitting jobs has continued to stay below the level seen before the pandemic threw the U.S. job market into disarray.

Economists consider the quits rate a measure of workers’ ability to switch jobs for higher pay, making ita proxy for changes in wage and benefit costs – with the current data pointing to an easing of labor cost pressures in line with continued progress on overall inflation.

RATE-CUT BETS

Other data may push the Fed in the other direction. A recent Conference Board survey showed consumer confidence jumping to a two-year high, something that could point to ongoing consumer spending at a time when central bank policymakers still feel aggregate demand needs to ease.

“Inflation is on a path to 2%, but data such as these portend slower progress … and may delay the first rate cut,” said Oren Klachkin, an economist at Nationwide.

Investors on Tuesday pared bets that the Fed would cut interest rates at its March 19-20meeting and shifted expectations higher for an initial rate reduction at the April 30-May 1 meeting.

Early on Wednesday the U.S. Labor Department is due to release the Employment Cost Index for the fourth quarter. The closely-watched report measures changes in the overall compensation paid to workers that includes wages and benefits.

Fed officials will receive another central piece of data on Thursday when the Labor Department releases productivity data for the fourth quarter. That report could provide a rationale for why inflation has continued to slow despite strong growth. Capping a week of data capturing the state of the labor market, the monthly jobs report for January will be released on Friday.
Source: Reuters (Reporting by Howard Schneider; Editing by Paul Simao)