© Reuters. FILE PHOTO: The US Federal Reserve Building in Washington, DC/
By Jamie McGeever
ORLANDO, Florida (Reuters) – For the Fed and the US economy, the hard part starts now.
Depending on the length of monetary policy’s ‘long and variable’ lull, most – perhaps even most – of the Federal Reserve’s 500 basis point rate increase since March 2022 has yet to be felt in the real economy.
As the US central bank approaches its “peak rate”, policymakers, consumers, businesses and financial markets find themselves in limbo – grateful for the apparently “soft landing” underway, but recognizing that the full impact of a tightening cycle is yet to come. come.
The amorphous lull sheds light on the cat-and-mouse game between the Fed and markets that has been in play since the central bank began its tightening cycle last year.
Eager to ensure that inflation is dead and buried, Fed officials have tried to steer interest rate markets away from easing financial conditions and bucking their longstanding view that policy will be eased as soon as the terminal rate is reached.
For their part, markets have long expected the Fed to quickly turn to a series of fairly aggressive rate cuts, largely to counter the accumulating sluggish effects of a tightening cycle.
With consumer price inflation dramatically dropping to 3% annually and the Fed’s rate hike campaign nearing its end, the ‘long and variable’ lag created by economist Milton Friedman in 1961 will now come under closer scrutiny.
NEW THUMB RULE
The old rule of thumb is that it takes about 18 to 24 months for monetary policy moves to be felt in the real economy. Seen at the most literal level, the 500 basis point tightening since March 2022 – 17 months ago – still hasn’t registered at all.
This will take a significant hit to employment and growth is sliding down. It’s not that simple of course, due to the transmission of tighter policies in the modern world via forward guidance, falling asset prices and tighter financial conditions are becoming more rapid.
There is a growing opinion that the lags have been much shorter since Friedman shared his ‘long and varied’ theory.
Fed Governor Christopher Waller in January said policy moves now have an impact in 9 to 12 months, and a Kansas City Fed paper in December found that “a peak inflation slowdown could occur about a year after policy tightening,” despite stressing “high” uncertainty. around it.
This means that a rate hike of 200 to 275 basis points – the cumulative tightening since last July, 12 months ago, or September, nine months ago – has yet to make itself felt.
Last September was when the Fed raised its federal funds target in the 3.00%-3.25% range, above what its officials perceive as a ‘neutral’ rate of around 2.5% which neither spurred nor slowed the economy.
If policy has been constraining all the time but not yet fully embraced, while inflation has dipped to 3% from 9%, there is a case to be made that the Fed’s job is pretty much done.
With inflation falling toward target and slowing at its most consistent pace in 100 years, and unemployment near a 50-year low, the central bank is close to fulfilling its dual mandate objective.
Data on Wednesday showed that consumer prices rose at an annualized rate of 3.0% in June, down from 4.0% in May. Annual inflation has now slowed for 12 straight months from a 41-year high of 9.1% last summer, the longest decline since the June 1920-June 1921 period.
“The disinflationary process is accelerating and now progressing,” economist Phil Suttle wrote on Wednesday.
Given the impending policy lag, talk will now likely turn to how much of the 150 basis point rate cut by the end of next year will actually feed into the rate market.
(Opinions expressed here are those of the author, a columnist for Reuters.)
(By Jamie McGeever; Editing by Paul Simao)