How can a smaller move send a big message? That’s the dilemma in which the Federal Reserve finds itself as it meets to discuss its a target short-term interest rate in the week ahead.
There’s no doubt the central bankers will raise the borrowing rate for the eighth consecutive meeting in their effort to tamp down generational-high inflation. And there is no doubt in the market they will hike rates by a quarter of a percentage point, according to the CME FedWatch Tool.
Such a “small” rate increase after much more aggressive changes comes with some big questions, though.
Should investors take it as a sign of confidence on the Fed’s part that it can wind down its inflation fight?
Does a lighter touch now risk having to return to an inflation fight in several months?
How does easing off its aggressive stance toward inflation impact the Fed’s reputation?
The seven previous rate hikes — most of them at a pace not experienced in decades — have yet to be fully integrated into the broad economy. Certainly, home sales have slowed as mortgage rates have shot up. Wage growth is slowing. And announced layoffs have become almost daily headlines in the technology and financial industries. Yet two weeks ago Federal Reserve Vice Chair Lael Brainard told a University of Chicago business school audience, “It is likely that the full effect on demand, employment and inflation of the cumulative tightening that is in the pipeline still lies ahead.”
The stock market has been encouraged by the possibility of a less aggressive Fed. Mortgage rates may cool down, helping to support housing. Consumer confidence may be buoyed by inflation pressures easing. And visibility into business conditions six months or more ahead may encourage businesses to keep hiring.
The stock market also has been worried by a less aggressive Fed. Inflation is far from whipped. Why should the central bank be right about inflation now when it was wrong on inflation on the way up? And if inflationary forces aren’t cured, a second surge would prolong the economic tourniquet of rising interest rates.
The Fed’s decision in the week ahead is a big one, even if it’s a small move.
Tom Hudson is a financial journalist and chief content officer at WAMU public radio in Washington, D.C. Follow him on Twitter @HudsonsView.