The Federal Reserve will announce the May interest rate decision on Thursday morning Beijing time. At the beginning of this year, top US economists believed that the Federal Reserve would use the May interest rate meeting to cut interest rates for the first time since initiating its toughest anti-inflation mechanism in 40 years. Now, as inflation is more stubborn than expected, economists have begun to weigh whether interest rate cuts will be postponed or completely cancelled.

The first quarter of this year was a difficult three months for the Federal Open Market Committee (FOMC), which is concerned about inflation. By the end of 2023, a rare combination of slowing inflation and job flexibility made the US economy's illusory “soft landing” seem within reach. However, the latest data shows that consumer prices have once again surpassed expectations, although economic growth slowed more than expected in the first three months of 2024.

According to data from the US Bureau of Labor Statistics, due to soaring energy prices and rising housing, health care, and insurance costs, if the trend of the past three months continues throughout the year, the US inflation rate will reach 4.5% again by March 2025. This is more than double the Federal Reserve's official target of 2%. These reports indicate a similar recovery in the inflation indicators favored by the Federal Reserve. Excluding food and energy, the core PCE price index grew at an annualized rate of more than 3.7% in the first quarter of 2024, before reaching the Federal Reserve's 2% target for two consecutive quarters.

Bankrate's chief financial analyst Greg McBride said that there is currently no reason for Federal Reserve policy makers to adjust interest rates because the historic hiring boom of employers kept the unemployment rate below 4%, the longest period since the 1960s. But for consumers, the message is still clear: interest rates on financing from mortgages to credit card loans are likely to remain high — a price that Federal Reserve officials believe is worth paying to curb inflation.

1. Economists say the threshold for cutting interest rates is still higher than raising interest rates

With nothing but bad news on inflation recently, economists and investors are beginning to wonder whether the Federal Reserve can justify the three rate cuts predicted by its officials in March. Rumors about whether the Federal Reserve will raise interest rates again have even begun to increase.

KPMG chief economist Diane Swonk wrote in a report: “Interest rates may not be cut at all in 2024. Earlier, a report released by the US Department of Commerce showed that economic growth has slowed and inflation has risen more than expected. At the US Federal Reserve meeting in May, some participants may raise discussions about the possibility of interest rate hikes.”

In any case, officials will let the data speak for themselves, and the US economy may change differently at the Federal Reserve's September meeting. According to most economists who are still predicting the Fed's interest rate cut, this is the fastest time that Fed officials are currently likely to cut interest rates. But aside from the Fed's next steps, the Federal Reserve's institutional transformation may already be underway, which will affect their response to these recent issues.

When the Federal Reserve first began raising interest rates, Federal Reserve Chairman Powell acknowledged that it might take a period of “below-trend” economic growth to reduce inflation to the target level. He said the Federal Reserve is willing to keep interest rates high, even if it means a recession or rising unemployment.

“This is the unfortunate cost of reducing inflation,” Powell said in his keynote address at the Global Central Bank Annual Monetary Policy Symposium in Jackson Hole in August 2022. At the time, the harshly worded central bank governor's speech triggered a sharp fall in the stock market and a sharp rise in bond yields, which continued until last fall. “But failure to restore price stability would mean more pain,” the analyst said.

In contrast, Powell admitted at the latest post-meeting press conference in March 2024 that the Federal Reserve may start cutting interest rates if the labor market “clearly weakens.” Luke Tilley, chief economist at Wilmington Trust, said, “One of the underrated things the Federal Reserve has done since January of this year is to make it very clear that from now on, both sides of the Fed's mission have been carried out equally. In those few years, the focus of attention was on inflation because the inflation rate was too high.”

As officials see the inflation rate fall from a 40-year high of 9.1% in June 2022 to 3% in June 2023, while the unemployment rate remains relatively stable, the mindset of prioritizing inflation may begin to change. Officials recognize that low unemployment does not necessarily lead to inflation. At the same time, the gap between the US national inflation rate and unemployment rate began to narrow.

The March CPI announced by the US Bureau of Labor Statistics was higher than expected for the third month in a row, and the records of the Federal Reserve's March interest rate meeting showed. Participants believed that the two goals of stabilizing inflation and maintaining maximum employment were “moving towards a better balance.” “They pointed out that it is important to weigh the risk of maintaining restrictive positions for too long (which may unduly weaken economic activity and employment) and the risk of easing policies too quickly,” the minutes said.

Meanwhile, Powell added in his April 16 speech that he believes it may still be appropriate to cut interest rates this year, although officials may wait longer than they initially thought to begin the process.

Another important factor to consider is the level of “real” interest rates. When asked if the Federal Reserve should raise interest rates further, Chicago Federal Reserve Chairman Goulsby said in his last speech before the Federal Reserve's upcoming meeting that as inflation slows, policies will continue to be tightened even if interest rates remain unchanged. These are probably the reasons why officials haven't seriously begun to discuss whether rising inflation requires further interest rate hikes — at least not yet.

Ryan Sweet, chief economist at Oxford Economics, said: “The threshold for raising interest rates has been raised significantly.” Sweet lowered his expectation that the Federal Reserve will cut interest rates for the first time from June to September. Currently, he only expects to cut interest rates twice this year. Sweet said, “To get the Federal Reserve to cut interest rates, they need to see a few more months of better inflation data. It doesn't have to be an obvious slowdown; things can't get any worse.”

2. Is inflation cooling faster or will it take longer to slow down? Only time will tell

As it stands, people hope that it will only take a little longer for inflation to fall back to 2%, rather than fully accelerate again. Economists say that price pressure is currently stuck in 3% purgatory, and there may be many reasons. First, tight supply and the Middle East conflict may be the reason for the recent rise in energy prices. According to CPI data, the increase in energy prices accounted for one-fifth of the February-March price increase.

To understand potential inflation, economists tend to track an indicator that doesn't include these fluctuating prices. The so-called core price fell from 5.6% in January 2023 to 3.8% in March, and has remained stable since February. Meanwhile, some of the current drivers of inflation — housing and car insurance — are likely to lag behind everything else. A new “experimental” rent index from the US Bureau of Labor Statistics, which aims to track housing costs in real time, shows that rent increases are the slowest since 2010, which is a sign that the housing market is about to cool down. Meanwhile, auto insurers have been increasing premiums to make up for the sharp rise in medical and maintenance costs over the past two years.

Sweet notes that in Bankrate's first-quarter economic indicators survey, economists acknowledged that the inflation rate may not reach 2% until the end of 2025 or 2026. Waiting for interest rate cuts gives Fed officials time to reassess whether inflation is stable or rising.

“I'm not really worried about whether recent inflation figures suggest inflation is moving in the wrong direction. We just ran into a little bit of a hindrance.”

However, risks remain. Although the Federal Reserve cannot influence the supply side of the economy, rising gasoline and fuel prices may affect consumers if companies have to pass on higher transportation costs by raising prices. McBride said, “Over the past few months, we have indeed seen substantial progress in reducing inflation. Falling gasoline and oil prices are our driving force. We're not in this situation right now; look, the inflation trend is different.”

3. Federal Reserve officials may adjust their balance sheet policies, which will affect investors' wallets

In addition to the Federal Reserve's interest rate policy, it is expected that the Federal Reserve will also announce plans to continue to adjust the cash flow in the banking system. This is a confusing yet important decision for consumers, as it could end up being another lever that affects the cost of borrowing they pay — especially if something goes wrong.

Since September 2022, the Federal Reserve has divested up to $60 billion in treasury bonds and $35 billion in mortgage-backed securities after rolling maturities. The Federal Reserve bought these assets after the pandemic, an “unconventional” monetary policy that effectively increased the money supply. The Federal Reserve expanded its balance sheet to stimulate demand and suppress longer-term interest rates such as 30-year fixed-rate mortgages. The opposite is also true. By letting assets expire, Federal Reserve officials are actually putting pressure on the credit supply in the economy.

However, Federal Reserve officials don't want to take this process too far. While normalizing the balance sheet after the financial crisis, officials lost control of a key interest rate in 2019, which should have remained within the target range of the federal funds rate expected by the Federal Reserve. Earlier, an analysis by the Federal Reserve Bank of Richmond found that although the federal funds rate remained in the target range of 2- 2.25% at the time, the repurchase rate soared to a high of 9% in one trading day.

The buyback market is often viewed as the “beating heart” of the financial market. Problems in this corner of the financial system could affect the entire US economy, making access to credit more difficult and temporarily more expensive. Officials now acknowledge that excessive balance-sheet contraction may have contributed to this dysfunction. At the time, officials had already withdrawn about $700 billion from the financial system. Today, however, they have taken away more liquidity — nearly $1.6 trillion.

Powell said at a press conference after the Federal Reserve's March meeting: “Sometimes, in general, reserves are sufficient, or even plentiful, but this is not the case in all regions. And where it isn't enough, it can be stressful. This may cause you to stop this process prematurely to avoid stress. Then it was hard to reboot.” Powell hinted at the turbulent repurchase market five years ago.

Powell revealed at the March meeting of the Federal Reserve that officials will soon discuss the next phase of balance sheet policy. There is an announcement on the discussion table about when the “downsizing” will begin and by how much.

The Federal Reserve plans to keep interest rates high for a longer period of time, which means that now is an important time for investors to prioritize plans to repay high-interest debts and establish emergency funds, so they can be fully prepared for any unexpected expenses. Higher long-term interest rates mean banks are still providing the best returns on consumer deposits in over 10 years. An added benefit of high returns is that it helps investors increase funds for unexpected expenses or long-term team goals more quickly. At current levels, an annual interest rate of 5.35% would generate $535 in interest on a $10,000 deposit.

Savers still have the opportunity to lock in these higher benefits over the long term through time deposits (CDs). The yield on 5-year and 1-year CDs fell rapidly as the Federal Reserve appeared to be about to cut interest rates. Now that prices have stabilized, the most important thing for consumers is that they continue to be above inflation. The best 1-year large deposit can lock in an annualized yield of 5.36%, while the 5-year large deposit currently has a maximum yield of 4.55%. If investors are willing to lock in these funds, then these yields may help ensure that you can still get the highest yield in 10 years, even if interest rates eventually start falling. McBride notes, “Paying off debt will be the fastest way to free yourself from the cost of interest. From a savings perspective, let the good times roll in.”