Fed's Jerome Powell not declaring victory yet as economy heads for soft landing

Fed chairman says it is 'so far so good', but cautions that economy could still take an unexpected turn next year

Fed chairman Jerome Powell speaks to reporters after the central bank paused US interest rates for a third successive meeting. Bloomberg

Markets reacted triumphantly after the Federal Reserve signalled it could cut interest rates multiple times next year, but Fed Chairman Jerome Powell sought to balance that optimism with a more cautious tone after suggesting rates have reached their peak.

The Fed ended its final policy meeting of the year by leaving interest rates unchanged at 5.4 per cent – their highest level in 22 years. By aggressively raising rates, the central bank has sought to rein in the surge in US inflation which had climbed to 9.1 per cent last year.

“As we approach the end of the year, it's natural to look back on the progress toward our dual mandate objectives,” Mr Powell told reporters, referring to price stability and full employment.

His remarks followed a statement from the Federal Open Market Committee (FOMC), which for the first time in its tightening cycle said that inflation has “eased over the past year” with the caveat that it still remains above the Fed's 2 per cent goal.

Headline inflation has climbed down considerably to 3.1 per cent while the unemployment rate remains low despite more people coming into the workforce.

And while the economy is not expected to post bumper numbers like in the third quarter, median projections estimate it will still grow at a healthy 2.6 per cent pace this year before slowing to a 1.4 per cent annual pace in 2024.

The data suggests that a soft landing – which sees inflation fall without a recession – has become a base case scenario for the Fed.

“These are things we've been wanting to see,” Mr Powell said, drawing a more dovish tone when discussing the path forward.

But he still sought to urge caution, pointing to a 4.0 per cent core inflation rate and that economic forecasts can change.

“Declaring victory would be premature,” he said.

“I think it's fair to say there is a lot of uncertainty about going forward. We've seen the economy move in surprising directions.”

What Mr Powell did express optimism in, however, is that the Fed will bring inflation down to 2 per cent.

New projections released by the central bank estimate that its preferred inflation metric will drop to 2.8 per cent, downwardly revised from their 3.3 per cent projection in September, before falling to 2.4 per cent in 2024 and 2.1 per cent in 2025.

Core inflation – which excludes food and energy – is projected to fall to 3.2 per cent this year before dropping to 2.4 per cent next year.

“It might actually take a little longer to get inflation down to 2 per cent. We will get to 2 per cent. But we will set policy according to what we actually see,” he said.

The dot stops here

Also inside the FOMC's statement was the word “any” attached to the phrase “additional policy firming”, a new indicator that Mr Powell said is an “acknowledgement that we believe that we are at the peak rate for this cycle”.

Updated Fed projections also confirmed this according to the “dot plot”, which shows where each Fed official believes interest rates will land at the end of a given year. Fed officials were unanimous in leaving rates unchanged, and no Fed official forecasted another rate increase.

“While participants do not think it is likely to be appropriate to raise rates further, neither do they want to take the possibility off the table,” Mr Powell said.

Mr Powell said the Fed moved “very far, very fast” in its tightening cycle and signalled he was pleased with the progress the central bank has seen in moderating inflation and the labour market coming back into balance.

“It's so far, so good,” he said.

The next question is “when will it become appropriate to dial back the amount of policy restraint … That's what people are thinking about, and talking about.”

However, he said Fed officials are only at the beginning of having these discussions.

A majority of Fed officials estimated that interest rates would fall to somewhere between 4.5 and 5.0 per cent by the end of next year, according to the dot plot. The median projection forecasts rates will fall to 4.6 per cent in 2024.

Traders, however, are more optimistic, believing that interest rates could be cut as much as 125 basis points to 4.0 per cent by December 2024, data from the CME Group showed.