Market expectation that the central bank will ease is partly driven by the presence of new faces on the seven-member Fed board in Washington. In addition to reappointing Powell, President Joe Biden named three new members and promoted Lael Brainard, who in past years has advocated slowing rate hikes, to Powell’s No. 2.
Other new Fed officials outside of Washington are economists who have long pushed for broad and inclusive employment. Among them: Austan Goolsbee, former chief economist to former President Barack Obama, who recently became head of the Chicago Fed and attended his first central bank policy meeting this week.
“There’s a pretty strong idea that they’re going to ease sooner than they say,” said former Kansas City Fed Chairman Thomas Hoenig, whose tenure included the 2008 financial crisis, when the economy was losing more than 700,000 jobs per month. “The pressure would be to say, ‘Well, we’re almost there, we can go back.'”
Fed officials on Wednesday are expected to raise rates another quarter of a percentage point, getting closer to the central bank’s 5% target for its main lending rate. The goal is to bring inflation down to 2 percent, less than half of where it is now.
The Fed wants to make sure it keeps rates high long enough to drive inflation completely to a minimum, fearing a repeat of the 1970s and 1980s when the central bank backed off, only to see price spikes return.
But investors are pricing in a greater than 75% chance that interest rates will be lower in December than in June, according to CME FedWatch. They are not convinced that the Fed will keep its key rate at an extremely high level for long, particularly if inflation continues to fall and unemployment starts to rise.
Inflation has fallen for six consecutive months, fueling hopes that the price hike is about to end. Quarterly data on corporate labor costs released on Tuesday shows that wage growth, a driver of inflation, also continues to decline.
Still, even as consumer price hikes have cooled off, Fed officials continue to talk tough on the idea of leaving borrowing costs high enough to keep inflation on its downward trend. They say wage growth will need to slow further. And Fed policymakers have publicly been up to speed on how fighting inflation is their top priority.
That tone could change if economic indicators allow some members of the rate-setting committee to demonstrate that inflation is coming down even without a significant rise in unemployment from its current 3.5%. The Labor Department is reporting January jobs numbers on Friday and they are expected to show a slower but still steady increase in job creation.
“There is a growing contingent on the committee that will be very uncomfortable going into the second half of the year without cutting [rates] while unemployment rises,” said Derek Tang, an economist at LH Meyer Monetary Policy Analytics, a research firm chaired by former Fed Governor Larry Meyer. [the unemployment rate is] going to climb in the 4s. All of this is in service of trying to reduce inflation, but when the rubber meets the road, things might look a little different.”
Brainard, a Fed vice chairman, recently highlighted high profit margins that could give companies room to retain workers, particularly as supply chains continue to improve and help them save costs. That means inflation could fall further without hitting the job market too much, he said.
Meanwhile, returning inflation to 2% in the near term may not even be feasible, depending on what’s causing it.
Officials like Goolsbee say that if the Fed tries to counter inflation caused by supply problems, rather than excessive spending, it could run the risk of a recession without actually cooling prices — what’s often referred to as “stagflation.” That complicates the risks facing the central bank, he told CNBC last year, before joining the central bank.
“The Fed has to balance some things that it doesn’t normally need to balance,” Goolsbee said at the time.
Other top regional Fed chairmen, who walked out of a polling place this year but are still part of the debate at rate-setting meetings, could also advocate a softer approach to the economy, like Boston Fed chief Susan Collins . In 2019, Collins, then a professor at the University of Michigan, advocated raising the central bank’s inflation target to slightly above 2% to give the job market more room to recover during downturns.
However, the committee’s final position will depend on how the economy actually evolves. Even Fed officials like Brainard or San Francisco Fed Chair Mary Daly, who have historically been viewed as “doves” — in central bank parlance, more concerned about job market damage than inflation risk — are resolved in the face of price spikes.
Politicians across the board said they don’t expect to cut rates this year because they will need to stay at a high level for a while to ensure high inflation doesn’t creep into the economy. This could prompt the Fed to hold the brakes much longer than the markets expect.
Tim Duy, chief US economist at SGH Macro Advisors, noted that more dovish officials still haven’t changed their rhetoric, “even given the extent to which the data has swung in their direction.”
And some officials have pushed for the central bank to be even more aggressive in the face of rising prices, including Minneapolis Fed Chairman Neel Kashkari and St. Louis Fed Chairman James Bullard. Kashkari, who before the pandemic was an outlier at sustaining particularly low rates, has insisted during this inflationary period on raising rates higher than officials’ median forecasts. He has a rate vote this year, as does Goolsbee.
“I’m just wary of assuming anyone’s background anymore,” Duy said.
Meanwhile, the direction of the debate could also change dramatically if Brainard leaves; She is currently a contender to replace Brian Deese as head of the White House National Economic Council, according to people familiar with the matter.
“Given the working relationship that she and Powell have had for several years, I think she really plays a big role in thought leadership and where things are going,” said Claudia Sahm, a former senior economist at the Fed.
However, even given the focus of Brainard workers, she will be pragmatic about how much progress is being made against inflation, Sahm said. “Maybe later in the year it will matter, but for now, dovish, hawkish, moderate: They’re looking for inflation.”