Key Indicators to Monitor as the Fed Establishes Interest Rates

Federal Reserve officials have signaled that there will be no change to the current target range for short-term interest rates, which stands at 5.25%-5.50%, during their two-day meeting beginning Tuesday. However, they are expected to engage in significant discussions regarding the U.S. economic outlook and potential policy responses based on recent data, which includes unexpectedly strong job growth and economic performance alongside rising long-term borrowing costs that may impede growth.

Key phrases to watch in the Fed’s post-meeting statement on Wednesday, as well as in Fed Chair Jerome Powell’s press conference, may provide insight into future interest rate direction.

Extent of Additional Firming

The Fed’s preferred measure of inflation was reported at 3.4% in September, a substantial decrease from last summer’s peak, yet still above the central bank’s target of 2%. It is anticipated that the post-meeting statement will indicate that further tightening of policy remains a possibility, as officials assess "the extent of additional policy firming that may be appropriate" to bring inflation back in line with the target. Any alterations to this phrasing could hint at policymakers feeling closer to achieving a sufficiently restrictive monetary policy stance.

Proceed Carefully

In his press conference following September’s decision to maintain the policy rate, Powell reiterated the need to proceed or move "carefully" on eleven occasions. This choice of wording reflects a more measured approach compared to last year’s aggressive rate hikes, which often saw increases of up to 75 basis points at a time. The emphasis on "proceeding" suggests that further action is likely, and the current pause should not be interpreted as permanent. Powell has also recently included the term "patience" to characterize the Fed’s policy approach, implying that they may hold rates steady for an extended period.

Fairly Close, Long Way to Go

Powell has remarked that the Fed’s policy rate is "fairly close" to the level needed to reduce inflation to 2% over the medium term, but acknowledged that the journey to achieve this target is still lengthy. Expect Powell to reiterate this sentiment or express similar ideas, indicating that the possibility of another rate hike remains and that interest rate cuts are not on the immediate horizon.

Term Premium

In recent discussions, Fed officials have pointed to increasing long-term borrowing costs and the subsequent tightening of financial conditions as factors in their decision to hold off on further short-term rate hikes. Should Powell attribute these increases to a "term premium," which refers to the extra compensation investors require for the added risk of holding long-term debt, this could signal that the higher rates may mean less need for the Fed to intervene further.

Softening Labor Market, Soft Landing

Powell has expressed the belief that easing inflation will necessitate a period of "below-trend" growth, defined as GDP growth below 1.8% but above 0%, along with a "softening" of labor market conditions, implying a slight increase in the current unemployment rate of 3.8%. Successfully managing this situation would reflect a "soft landing," where the economy slows without crashing, and the labor market cools without collapsing. While Powell remains optimistic about achieving a soft landing, he has stressed that reducing inflation is the Fed’s foremost objective.

Bias and Balance of Risks

Analysts often describe the Fed’s current policy as having a hawkish "bias," suggesting an inclination toward a potential rate hike rather than a neutral stance. While Powell does not typically use this term, he and colleagues often discuss the "balance" of risks associated with underacting on rate hikes, which could allow inflation to remain elevated, versus overreacting and endangering the economy. Some of Powell’s colleagues have indicated that these risks currently appear to be roughly balanced, a sentiment that Powell has not echoed.