Fed Faces Pivotal Decision: When To Pause Interest Rate Hikes

Federal Reserve Chair Jerome Powell testifies before the Senate Banking Committee March 7, 2023 in Washington, DC. Powell spoke on the state of the U.S. economy and suggested that interest rates will need to stay higher for longer than expected in order to curb inflation

Win McNamee / Getty Images

The Federal Reserve faces a key decision this week that could determine if the economy goes into a recession—whether this week’s widely-expected rate hike will be its last. 

With inflation still running well over the Fed’s 2% goal and unemployment still hovering near record lows, financial markets are nearly certain the central bank will raise its benchmark interest rate another quarter-point when it meets Wednesday. That bump would bring the federal funds rate to the highest its been since 2006. 

Less certain is whether the central bankers will signal plans to raise rates yet again at their June meeting or keep their options open.

The Fed’s course for future rate hikes is a high-stakes decision for an economy and a banking system already showing signs of distress under the current interest rates, all against the backdrop of a looming crisis over the debt ceiling.  

“Recession over the next 12 months is avoidable given the economy’s resilience and assuming some reasonably good policymaking,” Mark Zandi, chief economist at Moody’s Analytics, wrote on Twitter Sunday. “The Fed must end its rate hikes after this week’s quarter-point increase, and lawmakers need to keep the drama over the debt limit from going off the rails.”

Whether the economy is still overheated with surging inflation, or on the path for a deep freeze and a recession depends on which data you look at. 

The labor market appears to still be running hot, with employees in high demand and commanding healthy pay increases despite highly publicized layoffs at tech and media companies. 

Inflation is falling more slowly than the Fed would like, with April’s 5% annual rate of increases for consumer prices still well over the Fed's target. Although, that rate is a big improvement from the June 2022 peak of 9.1%.

On the other hand, signs of an impending slowdown are mounting. 

Banks have grown more reluctant to lend money over the last year, which usually causes companies to reduce their labor forces. Overall economic growth as measured by GDP has slowed to a crawl, and a slew of leading economic indicators measured by economists at The Conference Board are flashing recession warning signs

The Fed’s interest rate hikes have exposed weaknesses in the banking system. Several institutions have completely melted down, including the collapse of First Republic this week. Further rate increases, meant to slow the economy and subdue inflation by raising borrowing costs and discouraging spending, could inflame these problems into a full blown crisis, economists say. 

The Fed, navigating these dangerous waters, is likely to leave itself room to adjust its approach at its next meeting, Ryan Sweet, Chief US economist at Oxford Economics said in a commentary. 

“The Fed will need to be careful in its new forward guidance to avoid painting itself into a corner,” Sweet said. “We think the forward guidance will come with a caveat along the lines that ‘the future path of monetary policy will depend on the evolution of data on growth and inflation.’

Traders mostly expect May’s rate hike to be the last. Bond markets have priced a 32% chance of another rate hike in June, according to trading data analyzed by CME Group’s FedWatch tool.

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  1. Federal Reserve. "Open Market Operations."

  2. Twitter. "@Markzandi, April 30, 2023, 10:08 a.m."

  3. Bureau of Labor Statistics. "Employment Cost Index Summary."

  4. Oxford Economics. "Economy is losing momentum but that won't deter the Fed."

  5. CME Group. "CME FedWatch Tool."

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