Rates rose in 2022 and 2023 at the fastest pace in four decades as the central bank sought to contain inflation. Today, as price pressures ease and the economy remains strong, Fed officials are prepared to lower rates at a slower and potentially less regular pace. Several have given hints in recent days about what this might look like in practice.

From 2004-2006, Alan Greenspan’s Fed pursued a policy of measured quarter-point hikes per meeting, which, according to some Fed officials, led financial markets to become too complacent, predictability that Fed officials may not mimic this time around. One option could be to make reductions in two stages, starting with a few quarter-point cuts followed by a potentially long pause. This was suggested by Fed Vice Chair Philippe Jefferson, who cited the mid-1990s when the Fed successfully engineered a soft landing for the economy by lowering rates, pausing for three meetings, and then cutting rates further.

Once the tightening policy has begun, the path forward will likely be less uniform and predictable than what the market anticipates. The Fed has no incentive to rush to provide accommodative measures. Even though the Fed generally lowers interest rates in response to recessions, the U.S. economy has remained surprisingly resilient. At 3.7%, the unemployment rate is nearly the same as when the central bank began raising rates in March 2022.

The last inflation report published this week will reinforce this view. Core inflation – which excludes volatile components such as food and energy and is the Federal Reserve’s preferred inflation gauge – increased in January at the fastest pace in nearly a year, rising by 0.4% in January and by 2.8% from last year.
Policymakers are paying particular attention to service inflation, excluding housing and energy, which tends to be more challenging to bring down. This indicator rose by 0.6% from a month ago, the most significant increase since March 2022.
Although a still robust labour market has supported consumer spending, high borrowing costs, fewer job offers, and persistent inflation should eventually weigh heavily on spending. The report shows that the largest drop hampered actual spending in January in goods spending in over a year. This was driven by the sharpest decline in vehicle purchases since mid-2021.

It was the latest PCE report that Fed officials will have access to before their March 19-20 meeting. Chairman Jerome Powell and his colleagues effectively ruled out a rate cut at this meeting, and investors are now looking to June as the most likely start date.

This strength, coupled with higher-than-expected inflation in January, reinforces the cautious approach taken by policymakers, not only for the first cut but also for future cuts. Officials have repeatedly emphasized the need to base their decisions on economic data.

Fed officials welcomed the surprising easing of price pressures at the end of last year, but some have warned that the improvement has concentrated mainly on energy and goods while service costs remain stubbornly high. Higher-than-expected employment and inflation figures have also changed market expectations, with investors now betting that the first rate cut will occur in June or July.