As prices fell sharply last summer, the Federal Reserve made plans to lower the U.S.’s high interest rates in preparation for its impending win over inflation. That plan is now in danger.
Why is that? Costs staying high.
In the past few months, prices have gone up a bit faster than expected. This makes people wonder when, or even if, the Federal Reserve will be able to reach its goal of stable 2% inflation. Policies that could cause inflation from the new Trump administration have made things even less certain.
Because of this, Wall Street DJIA 1.24% SPX 0.68% no longer thinks the Fed will cut rates as quickly or as deeply as investors thought a few months ago.
Whether the Fed can achieve its 2% [inflation] goal is an open question.
Richard Moody
“Prices are under pressure in many parts of the economy,” said Richard Moody, chief economist at Regions Financial. “It’s not clear if the Fed will be able to reach its 2% inflation goal.”
Fight against rising prices
It’s true that the rate of inflation has slowed down a lot. The economy is getting back to normal after all the problems that caused prices to rise during the pandemic have been fixed.
In the year ending in October, the Fed’s favorite price barometer rose by about 2.3%, down from a 40-year high of 7.2% in the middle of 2022.
Experts also say there’s a good chance that the 12-month rate of inflation based on the PCE measure, which the Fed likes, will reach or even drop below the 2% goal in early 2025.
The trouble is that inflation will stay high.
Rent and house prices going up, which are the biggest costs for most Americans, have been the biggest problem for the Fed. The price of housing is still going up at a very fast rate of 5% per year and hasn’t gone down as much as people thought it would.
But it’s not just to stay safe. Also, the prices of services like car repairs, insurance, and financial advice are going up much faster than they did before the pandemic.
Engineer and chief market strategist at New York Life Investments Lauren Goodwin said, “If your home needs maintenance, material costs are higher.” “The same thing is causing car insurance rates to go up.”
It seems like inflation is getting even worse when you look at it through the “core rate of PCE index.” This rate doesn’t include the more volatile food and energy prices and is thought to be the best way to predict future inflation.
In the year that finished in October, the core rate rose by about 2.8%, which is a lot less than the Fed’s goal of 2%.
“The “last mile” in the fight against inflation has been much longer than expected,” The Burning Glass Institute’s head economist Gad Levanon said. “And it’s not clear that inflation will go down even more in 2025.”
“Hammer” in the road?
It has been noticed by top Fed officials that inflation has recently “bumped.” Chairman Jerome Powell even said that the central bank “is in no hurry” to cut interest rates.
Still, most Fed officials are sure that 2% inflation is possible. They think that rent and staff costs will go down even more.
“I remain confident that inflation is moving sustainably toward our 2% goal,” Fed Chair Lisa Cook said on Wednesday. “Even if the path is sometimes bumpy.”
Few people are sure, including at least one of Cook’s coworkers.
One of the so-called “hawks” on the board, Michelle Bowman, said, “Progress in lowering inflation appears to have stalled.”
Steve Blitz, the experienced chief economist of TS Lombard, says that the economy kept growing strongly after the Federal Reserve raised a key short-term interest rate to the highest level in 23 years in 2023. At 4.1%, the jobless rate has also stayed at an all-time low.
The man said, “You are not going to get another big drop in inflation in that situation.” “Usually, when inflation goes down, it’s because the economy gets worse and unemployment goes up a lot.”
Blitz has warned the Fed many times that cutting rates too quickly could extend the period of high inflation, which would strengthen an economy that was already strong and push up the costs of labor and materials.
Also, big changes in the world economy pose a longer-term threat to the Fed’s goal of 2% inflation.
Free trade and globalization were some of the things that kept prices low from 2000 to 2020, but now they are going the other way. Companies could get their goods from countries with low costs and have cheap workers make them.
Those days look like they’re ending.
Moody said, “The drivers of the secular decline in inflation in recent decades are going away or moving in the wrong direction.” He was referring to the tariffs that the first Trump administration put on China and that the Biden White House kept in place. In his second term, Trump wants to raise taxes even more.
Moody said that the Fed might have to get used to low inflation rates of 2.5% to 3%.
Trump’s wild card
While the Fed thinks about how much to lower interest rates, Trump’s victory could add another problem to their road.
Some of his policies, like deregulation, might help lower inflation, but experts say that other policies, like higher tariffs, mass deportations, tax cuts paid for by deficits, and more government spending, could make prices go up even more.
That being said, no one knows how they will affect the economy until the new administrations make policies and Congress accepts them, which could take a while.
“Do we need inflation to reach 2% before trade and fiscal policies start to change things?” “That’s a story for 2026, not 2025.” It was said by Michael Pearce, who is the deputy top U.S. economist at Oxford Economics.
The Fed would have more time to think about how Trump’s policies will affect the economy before choosing how much to cut rates in 2025 and 2026 if they took a “go-slow” approach.
As Moody put it, “they can buy time to see how policy changes over the next year.” “That’s one more reason for them to move more slowly.”
“Keep an eye out”
What’s next?
Investors and experts still believe that the Federal Reserve will lower interest rates once more in December, making it three times this year that they have done so. Then take a break to see if inflation starts going down again.
Blitz said, “They are going to watch and wait.”
It’s not clear what a “go-slow” approach would mean for the business as a whole, but some Americans would find it hard to accept.
The people who would be hurt the most are home buyers who have to deal with high mortgage rates, makers who are in a slump, small businesses that need loans, and Americans with lower incomes who have to deal with high prices, high rates, and high debts.
Goodwin said, “This reality makes winners and losers.”
