Economists are concerned that the Fed, partly due to basing policy on inflation forecasts that are too pessimistic, will hike rates so high — or keep them elevated for an extended period — to the point that it tips the US into recession. The upcoming GDP report is expected to show the economy grew at a slower pace at the end of the year, but still supported by robust consumer spending on services.
Beyond that, the outlook is cloudier. Forecasters see GDP contracting in the second and third quarters as spending stagnates, business investment wanes and industrial production weakens, according to a Bloomberg survey of economists conducted earlier this month. That puts the odds of a recession over the next year at 65%.
Inflation is notoriously difficult to predict, and the Fed has been caught off guard in the past. Critics, and even several officials themselves, say the central bank moved too slowly with its hiking campaign last year, and messaging is key to keep market expectations in check.
“They don’t want to sound dovish because they don’t want financial conditions to ease too much so they need to keep up the tougher talk, but it’s also real because inflation could move back up,” said Luke Tilley, chief economist at Wilmington Trust Corp., who previously worked at the Philadelphia Fed.
So while the PCE data will likely reinforce that inflation is cooling, it’s too soon for the Fed to declare victory. Policymakers will insist they need to see more evidence that price gains are in fact ebbing before discussing pausing rate hikes, particularly in wage measures like the employment cost index and average hourly earnings to be released next week.
“If you want to prevent the forest fire, you need to make sure the embers of the campfire are fully extinguished. We are not there yet,” said Carl Riccadonna, chief US economist at BNP Paribas. “So they may want to move forward more slowly, but they still want to continue hiking.”
--With assistance from Matthew Boesler and Chris Middleton.
This article was provided by Bloomberg News.