The Fed Gears Up to Show Its Hand: One Cut, Two or None at All

After concluding a rapid series of rate rises last year, Fed officials remain widely united that the best course of action for an economy with solid growth and inflation still running somewhat above their target is to make no moves. In effect, they are taking the summer off to evaluate how hiring, spending and inflation are faring one year after they lifted rates to a two-decade high.

The central bank is on track to hold steady its short-term benchmark rate in a range between 5.25% and 5.5% on Wednesday. Officials are also likely to keep the guidance in their closely parsed policy statement that teases that their next rate move is more likely to be down than up.

That explains the intense spotlight on rate projections revealing how many officials anticipate one or, possibly, two rate cuts this year depending on their economic outlook. The exact distribution could be shaped at the last minute by a widely watched inflation report to be released Wednesday morning, hours before officials publish their own projections that afternoon.

A balancing act

The central bank’s leaders have been walking a tightrope this year. There are more signs emerging that the serious labor-market shortages and imbalances of the past three years have resolved without any meaningful increase in unemployment, raising questions over whether the labor market might soften at the margins.

For the past two years, several officials have suggested they could avoid the normal trade-offs that occur when they try to slow the economy because falling demand for workers could lead companies to simply scrap unfilled job vacancies rather than fire workers. Recent data on job hiring, quitting and openings suggest labor-market conditions have moved much closer to the levels seen in 2018 and 2019, before the pandemic.

“We’re getting to that point where the traditional relationships are going to start popping out,” Fed governor Christopher Waller said last month.

Still, economic activity has been solid. And a steady downturn in inflation over the second half of last year has stalled this year, giving officials less confidence that the downtrend will continue.

Prices rose 2.7% in the 12 months through April, down from 4.4% in the 12 months before that, according to the Fed’s preferred measure of inflation. But prices rose an annualized 2.9% over the six months through April, up from 2.4% for the six months before that. The Fed targets 2% inflation over time.

Fed Chair Jerome Powell and his colleagues don’t want to cut rates without more convincing evidence that their policy stance is as restrictive as they think it is. They are uneasy, however, that it will be too late to avoid a more serious employment downturn by the time they see that evidence.

A series of inflation readings that are persuasively benign would liberate them from this trap. Otherwise, it will likely require signs of greater-than-anticipated economic weakness to initiate rate cuts. In 2001 and 2007, initial rate cuts preceded a recession by a few months, leading the Fed to slash rates faster. After softness in 1995 and 2019, officials made a few cuts and stopped after the economy avoided a downturn.

The dot plot

Because no meaningful policy changes are expected at this week’s meeting, the focus Wednesday will center on new quarterly rate projections, the so-called “dot plot.” In March, most officials penciled in two or three cuts this year; the median—or midpoint—of the 19 officials was at three, but just barely. That was before a third consecutive disappointing inflation report, which subsequently prompted investors to wonder whether the Fed would be able to cut rates at all this year.

Investors’ intense focus on the median projections, which has at times sown confusion, adds a potential rare element of surprise to the gathering for two reasons.

First, most of the blocking and tackling for Fed meetings happens in the days and weeks leading up to the gathering. But Wednesday faces a wild card because those rate projections could be revised depending on the Labor Department’s report for May inflation as measured by the consumer-price index. The report will be released at 8:30 a.m., around 30 minutes before policymakers typically reconvene for their second day of deliberations.

A disappointing inflation report could hold more officials to a projection of no more than one cut this year. A serene report could lead more of them to pencil in two cuts.

Second, those projections aren’t the result of committee deliberations, even though investors—and occasionally Fed officials—treat them that way. The difference between a median that shows no more than one rate cut versus a median of two or more cuts could be determined by just one or two policymakers.

The Fed meets again in July and September. 

Many investors assume a median projection of two cuts would be needed to tee up a rate cut by September. A median of just one would imply rate cuts aren’t likely to start until even later in the year. “It would be taken as a pretty strong signal,” said Jan Hatzius, chief economist at Goldman Sachs.

Some officials who are on the fence about cutting twice this year could pencil in just one reduction to keep their options open. While the projections aren’t a promise of future action, some analysts have said a base case of one cut could be a way to effectively underpromise and overdeliver if inflation data turns out to be placid this summer.

Birds in stalemate

Those projections could also tease at looming disagreements that have, for now, been papered over by solid hiring and growth data. Policy “hawks,” or officials who are more worried about high inflation, aren’t actively agitating for a return to hiking rates and for now appear comfortable to simply retire any thought of cutting them.

On the other hand, policy “doves,” or officials who are more concerned about causing unnecessary economic weakness by holding rates high, will have very little ammunition to push for a rate cut soon without better news on inflation, including with Wednesday’s report.

That likely leaves September as the earliest opportunity to reduce rates absent a dramatic deterioration in the economy. And notwithstanding potential cues from the dot plot, it could be difficult for officials to send a strong signal about that meeting with three more months of data on inflation, hiring and spending between now and then.

Write to Nick Timiraos at Nick.Timiraos@wsj.com

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