‘The last mile is harder’: Stubborn inflation stalls Fed rate cuts

The Federal Reserve delighted markets last week by signaling it will stay the course with three interest rate cuts this year. The ensuing batch of economic indicators is starting to challenge that reassuring confidence.

The government reported Friday that the Fed’s preferred inflation gauge rose 0.3 percent month-to-month in February, following a January uptick that was the largest in a year. The data showed prices have risen 2.5 percent over the past 12 months, far better than inflation readings compared with a year ago but still stubbornly above the Fed’s 2 percent target.

That comes on top of other data points from the last few days that may give the Fed pause as it decides when to begin reducing rates. The indicators continue to show that the economy is performing more strongly than expected, despite elevated borrowing costs.

“I see economic output and the labor market showing continued strength, while progress in reducing inflation has slowed,” Fed Governor Christopher Waller told the Economic Club of New York on Wednesday. “Because of these signs, I see no rush in taking the step of beginning to ease monetary policy.”

For now, Fed Chair Jerome Powell doesn’t seem overly worried that progress on inflation is slowing — but he also isn’t in a rush to cut rates.

“We will be careful about this decision because we can be,” Powell said Friday at an event hosted by the San Francisco Fed, citing the strength of the economy. He acknowledged that the inflation reports in January and February were not as good as those in several of the previous months.

“We’ve been saying we expect inflation to move down to 2 percent but on a path that is sometimes bumpy," he said. "So the question then is are those just bumps, or are they something more than bumps?”

While the economy is surprisingly strong, the concern is that higher rates are putting pressure on households and businesses looking to borrow, weighing on hiring, investment and the housing market. So the longer the Fed cuts into growth, the more pain it could end up inducing later on. But there are a few troubling signs.

Friday’s inflation report showed that so-called core inflation, which strips out more volatile food and energy prices and is therefore a more reliable indicator of where prices might be headed, is still coming in more strongly than central bank officials would like to see.

The economy itself has also been resilient, though Powell has made clear that solid growth on its own is not a reason to keep rates at punishing levels, unless it’s also feeding inflation. The Commerce Department’s final read on gross domestic product for the fourth quarter of 2023, 3.4 percent, came in higher than the government’s previous estimate, showing that economic output grew even faster than initially reported at the end of last year.

Commerce also said gross domestic income, an alternate benchmark that tallies earned income and costs rather than GDP’s value of goods and services produced, surged by 4.8 percent, the highest rate since the end of 2021.

While GDP and GDI are backward-looking, more recent evidence also raises questions about whether the Fed needs to relax rates soon.

Financial markets have been soaring, with stocks and bitcoin hitting new records this year. The S&P 500 is having its best first quarter since 2019. The increases have been driven in part by the Fed halting its rate-hike campaign and pivoting to potential cuts.

As for the persistently strong labor market, data out Thursday showed that jobless claims last week fell by 2,000 to 210,000. The four-week moving average also fell. An increase in jobless claims would be a sign of an economic slowdown.

Apollo chief economist Torsten Slok flags a growing tension for the central bank: The “long and variable lags” of the Fed’s rate hikes — moves made to slow the economy enough to tame inflation — have been overwhelmed by the surge in the S&P 500 since November. He cites strong employment growth in January and February, low jobless claims and upward inflation pressure.

“The bottom line is that the last mile is harder because of the immediate positive impact on the economy of record-high stock prices,” Slok wrote Tuesday.

Other economists — and some Fed officials themselves — cite evidence that indicates the economy is getting to the point where interest rates may need to be dialed back.

RSM US chief economist Joe Brusuelas wrote Thursday that the Fed should start easing in the near term. At stake, according to Brusuelas, is a potential tip toward higher unemployment and sub-trend growth.

It underscores concerns that a Fed decision to keep rates at current levels will have an outsize negative impact on the economy as inflation recedes, with inflation-adjusted “real” interest rates rising.

Powell, for his part, said the central bank is watching risks to both price stability and employment.

Given the combination of shocks that the economy has experienced from the Covid pandemic and its knock-on effects, “we have to be unusually humble about our ability to see the future,” he said.