The Fed confronts an unusually confusing economic moment
By Bryan Mena, CNN
Washington (CNN) — The Federal Reserve has remained mum about interest rates as inflation concerns have heightened, leading to confusion about the state of the US economy.
Inflation slowed sharply in June, according to the latest Consumer Price Index, largely due to lower energy prices that month. Investors took that as a sign that the Fed might feel less compelled to hike interest rates to combat price pressures for the first time since July 2023.
But the conflict in the Middle East has intensified in recent weeks, triggering a spike in global energy prices. Brent crude, the global oil benchmark, crossed $100 a barrel Thursday for the first time since May. Meanwhile, Fed officials are debating how the AI infrastructure build-out could impact inflation.
The economic crosscurrents have made it difficult to understand where inflation is headed. On top of that, Fed Chairman Kevin Warsh hasn’t provided any guidance. Wall Street is unsure whether the Fed next week will hold its benchmark lending rate steady for the fifth consecutive meeting, or raise rates, according to futures — a lack of clarity not seen in years.
“The Fed is looking at all these inflationary impulses and determining if they will be there over the longer term,” Narayana Kocherlakota, an economics professor at the University of Rochester and former president of the Federal Reserve Bank of Minneapolis, told CNN.
“But it’s becoming very difficult to know what the Fed is going to do in the next few months, because Chair Warsh has been studiously uncommunicative about how the Fed is going to react to these changes in economic conditions,” Kocherlakota said.
‘A complete unforced error’
As Fed chairman, Warsh ditched a long-held practice known as “forward guidance.”
Since 2000, Fed officials have given forward guidance in the spirit of transparency so Wall Street would have an idea of where interest rates were headed. In his confirmation hearing in May, Warsh said he wouldn’t speculate on the economy’s path as chairman.
The jury is out on whether Warsh’s decision is working out.
“It’s going to lead to market volatility,” said Kocherlakota. “It makes businesses more reluctant to invest, meaning they’ll be less likely to demand workers to build the kinds of goods and services … because they’re uncertain about what the Fed is going to be doing.”
“That kind of uncertainty, in my view, is a complete unforced error on the part of the Fed,” he added.
On the other hand, some argue that Fed officials spoke too frequently about the economy in the past.
“We got to a point where the dissection of the Fed’s forward guidance was so acutely broken down into parts that I’m not sure it helped in the way it was meant to help either,” said Kezia Samuel, chief market strategist at wealth management firm AssetMark.
Risks of higher inflation
Fed officials largely agree that the central bank shouldn’t hike interest rates because energy prices will eventually come down on their own.
“Conventional wisdom among central bankers is to look through one-time price increases, such as those associated with higher tariffs and a jump in oil prices,” Fed Governor Christopher Waller said this month.
But the longer these price pressures persist, the greater the risk that inflation broadens well beyond the energy market and sticks around for longer. This could begin to erode Americans’ faith that inflation will eventually slow toward the Fed’s 2% annual target.
To get a sense of inflation’s direction, officials focus on so-called core measures of inflation that strip out volatile food and energy prices. Core inflation gives economists and policymakers a good sense of how persistent price pressures may be, and to gauge Americans’ view of prices, officials look at market and survey-based measures of inflation expectations.
Neither of those measures warrant imminent rate hikes, but that could change if the Iran war spirals out of control or persists for an extended period.
Meanwhile, Fed officials are closely watching Big Tech’s massive spending on AI data centers, which was discussed at the Fed’s June policy meeting.
“Many participants noted that ongoing strong demand for AI infrastructure would likely sustain upward pressure on prices for technology products and electricity,” the meeting’s minutes read. “Most participants remarked that growth in economic activity that exceeded that of potential output, owing in part to strong AI business investment, could contribute to more persistent inflationary pressures.”
The-CNN-Wire
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