Federal Reserve officials, increasingly confident they have nipped a potential financial crisis in the bud, now face a difficult judgment on whether demand in the U.S. economy is falling and, if so, whether it is coming down fast enough to lower inflation.
If the U.S. central bank's policy meeting two weeks ago was dominated by concern that a pair of bank failures risked broader financial contagion - a potential reason to pause further interest rate increases - debate has quickly refocused on whether tighter monetary policy has started to show its impact on the broader economy, or if rates need to rise higher still.
Richmond Fed President Thomas Barkin struck a similar note last week. "Inflation is still very high. The job market is still very tight," he told reporters. "When you raise rates there's always the risk of the economy softening faster than it might have otherwise. If you don't raise rates, there's the risk of inflation getting out of control."
Investors currently regard the Fed's rate decision next month as a toss-up, the first time that has been the case since the current tightening cycle began in March of 2022.At the last Fed meeting, Powell noted that even if further bank failures are avoided, lending institutions may still become more cautious and, by curbing access to credit, slow the economy faster than anticipated.
"People will continue to spend as long as they get paid," said Yelena Shulyatyeva, senior U.S. economist with BNP Paribas. "They get a little bit less access to credit, is it going to really affect the decisions? It will, but only at the point at which they stop getting paid" because of a slowing economy and rising unemployment.
Karen Dynan, a Harvard University economics professor and senior fellow at the Peterson Institute for International Economics, said her outlook was for the Fed to face a "slog" against inflation that will require more rate increases but, because of the strength of household balance sheets and the labor market, skirt a recession.
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