U.S. Economy’s Staying Power Poses Big Questions for the Fed

on Jun8
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Employers are hiring rapidly. Home prices are rising nationally after months of decline. Consumer spending climbed more than expected in a recent data release.

America’s economy is not experiencing the drastic slowdown that many analysts had expected in light of the Federal Reserve’s 15-month, often aggressive campaign to hit the brakes on growth and bring rapid inflation under control. And that surprising resilience could be either good or bad news.

The economy’s staying power could mean that the Fed will be able to wrangle inflation gently, slowing down price increases without tipping America into any sort of recession. But if companies can continue raising their prices without losing customers amid solid demand, it could keep inflation too hot — forcing consumers to pay more for hotels, food and child care and forcing the Fed to do even more to restrain growth.

Policymakers may need time to figure out which scenario is more likely, so that they can avoid either overreacting and causing unnecessary economic pain or underreacting and allowing rapid inflation to become permanent.

Given that, investors have been betting that Fed officials will skip a rate increase at their meeting on Tuesday and Wednesday before lifting them again in July, proceeding cautiously while emphasizing that pausing does not mean quitting — and that they remain determined to bring prices under control. But even that expectation is increasingly shaky: Markets have spent this week nudging up the probability that the Fed might raise rates at this month’s meeting.

In short, the mixed economic signals could make Fed policy discussions fraught in the months ahead. Here’s where things stand.

Interest rates are above 5 percent, their highest level since 2007.

After sharply adjusting policy over the past 15 months, key officials including Jerome H. Powell, the Fed chair, and Philip Jefferson, President Biden’s pick to be the next Fed vice chair, have hinted that central bankers could pause to allow themselves time to judge how the increases are affecting the economy.

But that assessment remains a complex one. Even some parts of the economy that typically slow when the Fed raises rates are demonstrating a surprising ability to withstand today’s interest rates.

Fed officials are also watching for signs that their rate increases are trickling through the economy to slow the job market: As it costs more to fund expansions and as consumer demand slows, companies should pull back on hiring. Amid less competition for workers, wage growth should moderate and unemployment should rise.

Some signs suggest that the chain reaction has begun. Initial claims for unemployment insurance jumped to the highest level since October 2021 last week, a report on Thursday showed. People are also working fewer hours per week at private employers, which suggests bosses aren’t trying to eke so much out of existing staff.

And by some measures, the labor market is still chugging. Hiring remains particularly strong.

“Everyone talks as if the economy moves in one straight line,” said Nela Richardson, chief economist at ADP. “In actuality, it’s lumpy.”

Officials will receive a related and more up-to-date inflation reading for May — the Consumer Price Index — on the first day of their meeting next week.

Economists expect substantial cooling, which could give officials confidence in pausing rates. But if those forecasts are foiled, it could make for an even more heated debate about what comes next.

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