Federal Reserve begins two-day meeting as US faces economic uncertainty

Policymakers expected to raise interest rates again in face of potential recession and debt default

Federal Reserve Chairman Jerome Powell has repeatedly pointed to the strength of the labour market as to why he believes inflation in the US will remain elevated for some time. AFP

The Federal Reserve on Tuesday began its two-day policy meeting as the US lurches towards a possible recession and debt default.

Policymakers at the Fed are under pressure to cut interest rates as banking crisis and recession fears linger, but that remains unlikely for now, with inflation still running hot.

Like the Fed's previous meeting, the latest verdict follows a bank failure: First Republic was acquired by JP Morgan on Monday after California state regulators seized the midsized lender.

First Republic's failure came about two months after Silicon Valley Bank's sudden collapse sparked fears of a new global financial crisis, leading the Fed to impose a smaller rate increase of 25 basis points.

The Fed is again expected to raise interest rates by another 25 basis points at the conclusion of its two-day meeting, data from the CME Group showed. It would be the central bank's tenth rate increase since March 2022.

From there, it is expected to keep interest rates steady until the end of the year.

Tightening lending conditions caused by the banking crisis are likely to constrain the US economy further, leading Fed officials to acknowledge the likelihood of a “mild recession”.

“Given their assessment of the potential economic effects of the recent banking-sector developments, the staff’s projection at the time of the March meeting included a mild recession starting later this year, with a recovery over the subsequent two years,” according to minutes released by the Fed from its March meeting.

The economy has already felt the implications of the Fed's aggressive rate raises. The nation's gross domestic product slowed to 1.1 per cent growth in the first quarter of 2023 after growing 2.6 per cent in the fourth quarter of 2022.

The housing market, which is particularly vulnerable to interest rates, shrank for the eighth consecutive quarter. And while the labour market has shown some signs of cooling, it still remains hot.

Government data released on Tuesday showed employers posted 9.6 million vacancies last month, the lowest level since April 2021, and layoffs rose to their highest level since March 2020.

Unemployment is still at a near-historic low of 3.5 per cent and wages increased by 4.8 per cent last month, adding to inflationary pressures.

Federal Reserve Chairman Jerome Powell has repeatedly pointed to the strength of the labour market as to why he believes inflation in the US will remain elevated for some time.

Even as recession fears could come into focus later this year, the risk of a debt default poses an immediate threat to the world's largest economy.

The US may be unable to pay its bills as soon as June 1 if Congress does not raise or suspend the debt limit before then, Treasury Secretary Janet Yellen said in a letter addressed to congressional leaders on Monday.

The US has never defaulted on its debt.

Failing to make good on its payment obligations would have disastrous consequences for the US. The federal government would no longer be able to pay for programmes such as Social Security, unemployment would soar, the US credit rating would be downgraded and a recession would be all but assured.

Mr Powell has previously called on Congress to raise the debt ceiling.

Republicans in the House of Representatives last month voted to raise the debt limit by $1.5 trillion. But President Joe Biden is resolute in his opposition to the proposal's cuts to federal agencies and other restrictions.

The White House's public position remains to raise the debt ceiling without conditions.

Mr Biden called for a meeting with congressional leaders on May 9.