The Federal Reserve is expected to slow the pace of its torrid interest rate hikes when it concludes its two-day policy meeting Wednesday, as consumer prices have showed evidence of cooling for two straight months.
The central bank is expected to raise its benchmark interest rate by half a percentage point to a new range of 4.25% and 4.5%, marking the highest level since December 2007.
The Fed will announce its latest policy decision at 2 p.m. ET on Wednesday, with a press conference held by Chair Jerome Powell set to begin a half hour later.
This move will usher in a slower phase of rate hikes after the central bank raised the target range for its benchmark interest rate by 0.75% at each of its last four policy meetings.
Fed Chair Jay Powell set the table for a 50 basis point rate hike last week, saying in a speech it, "makes sense to moderate the pace of our rate increases as we approach the level of restraint that will be sufficient to bring inflation down."
“The Fed has made clear they’ve moved a lot and because their actions take effect with a lag, they do need to wait and be patient to see how much the increase bites into the economy in coming months,” Tony Roth, Chief Investment Officer at Wilmington Trust, said in an interview.
The Fed is walking a fine line between raising rates too much and causing a recession, but not raising rates enough to cool inflation.
Some encouraging signs on the inflation front, however, appear to be emerging.
Wednesday's announcement will come just a day after U.S. inflation data showed a slowdown in price increases for the second-straight month.
"Core" inflation, which strips out the more volatile food and energy components and is the Fed's preferred way of gauging price pressures, rose 0.2% month-on-month and 6% over the prior year in November. In October, "core" inflation rose 0.3% and 6.3% on a monthly and annual basis, respectively.
Headline inflation, which includes all categories, rose 7.1% annually in November.
“The Fed could dismiss the better-than-expected October [inflation] report as just one month’s data, but the further slowdown in November makes this new disinflationary trend much harder to ignore,” Paul Ashworth, chief economist for North America at Capital Economics, wrote to clients on Tuesday.
Ashworth added: "Tuesday's report provides strong support to our long-held view that mounting disinflation will soon persuade the Fed to move to the side line after one additional 25bp hike in early February."
Though the Fed may slow the pace of rate hikes, Powell and other officials have said rates will need to move higher than projections from September, which suggested rates would peak around 4.6% next year.
Since that meeting, Fed officials have socialized the idea of rates settling near 5% before the central bank ends this current tightening cycle. On Wednesday, the Fed will release an updated set of economic forecasts, which includes officials' expectations for interest rates over the next several years.
Roth told Yahoo Finance he thinks rates will rise to around 5%, but could get as high as 5.25%.
“I don’t think it will be much higher than that because I think we’ll see a deterioration in the consumer’s balance sheet and that will slow down services inflation,” Roth said.
For the Fed to raise rates much higher than 5%, Roth says the economy would need to remain strong and not enter a recession. Wages would also need to continue growing on a positive basis around 2-3%, raising the prospect of a wage spiral where higher prices lead to higher wages leading to even higher prices, in Roth's view.
Fed officials have said they expect to hold rates at a peak level for “some time,” officials say. But how long is that?
New York Fed President John Williams doesn’t see that happening until 2024. Yet markets are pricing in rate cuts starting in the second half of next year.
How Powell squares those tensions will be a key focus for investors on Wednesday.