Is the Fed still in a 'good place'?
ORLANDO, Florida, June 12 (Reuters) - At the Federal Open Market Committee meeting next week, investors will scrutinize all communications for any sign that the recent softening in U.S. inflation could be enough to nudge policymakers closer to cutting interest rates.
Current economic data might be leaning in that direction, but policy out of Washington could well keep Chair Jerome Powell and colleagues in 'wait and see' mode.
No one expects the Fed to cut rates next week, but businesses, households and investors should get a better sense of policymakers' future plans from the revised quarterly Staff Economic Projections and Powell's press conference.
Powell was very clear in his post-meeting press conference last month that the Fed is prepared to take its time assessing the incoming economic data, particularly the impact of tariffs, before deciding on its next step.
He told reporters no less than eight times that policy is in a "good place" and said four times that the Fed is "well positioned" to face the challenges ahead. Will he change his tune next Wednesday?
Annual PCE inflation in April was 2.1%, the lowest in four years and virtually at the Fed's 2% target, while CPI inflation in May was also lower than expected. The labor market is softening, economic activity is slowing, and recent red-hot consumer inflation expectations are now starting to come down.
In that light, it may be surprising that markets are not fully pricing in a quarter-point rate cut until October.
"The upcoming meeting offers an opportunity (for Fed officials) to signal that the recent mix of tamer inflation and softer consumption growth warrant a careful 'recalibration' of rates lower, while remaining very cautious about what comes next," economist Phil Suttle wrote on Wednesday.
But there are two well-known barriers that could keep the Fed from quickly re-joining the ranks of rate-cutting central banks: tariffs and the U.S. fiscal outlook.
Tariffs have yet to show up in consumer prices, especially in goods, and no one knows how inflationary they will be. They could simply result in a one-off price hit, they could trigger longer-lasting price spikes, or the inflationary impact could end up being limited if companies absorb a lot of the price increases. In other words, everything is on the table.
Equity investors appear to be pretty sanguine about it all, hauling the S&P 500 back near its all-time high. But Powell and colleagues may be slower to lower their guard, and for good reason.
Although import duties on goods from China will be lower than feared a few months ago and Washington is expected to seal more trade deals in the coming weeks, overall tariffs will still end up being significantly higher than they were at the end of last year, probably the highest since the 1930s.
Economists at Goldman Sachs reckon U.S. inflation will rise to near 4% later this year, with tariffs accounting for around half of that. This makes the U.S. an "important exception" among industrialized economies, the OECD said last week.
The other major concern is the U.S. public finances. President Trump's 'big beautiful bill' being debated in congress is expected to add $2.4 trillion to the federal debt over the next decade, and many economists expect the budget deficit will hover around 7% of GDP for years.
With fiscal policy so loose, Fed officials may be reluctant to signal a readiness to loosen monetary policy, especially if there is no pressing need to do so.
FOMC members in December last changed their median forecasts for the central bank's policy rate, hiking it this year and next year by a hefty 50 basis points to 3.9% and 3.4%, respectively. They left projections unchanged in March amid the tariff fog.
That implies 50 basis points of rate cuts this year and another 50 bps next year, which is pretty much in line with rates futures markets right now. So perhaps Fed policy is still in a "good place", but with economic expectations changing quickly, it's unclear how long that will be the case.
(The opinions expressed here are those of the author, a columnist for Reuters)
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