Getting inflation under control remains priority No. 1 at the Federal Reserve. New inflation data out Friday shows that U.S. prices moderated in February, led by a cooling in the cost of services (outside of housing and energy), according to a Commerce Department report.
The report also revealed that consumer spending rose to its highest level in over a year. And while all signs point to a strong, resilient economy, Fed Chair Jerome Powell is still toeing a line of cautious optimism before claiming victory in the fight against inflation.
Personal consumption expenditures (PCE), the Fed’s favorite inflationary gauge, rose 2.8% annually in February, down from January’s reading of 2.9%, according to the Commerce Department.
The reading was “in line with expectations,” Powell said Friday during a moderated discussion at the San Francisco Fed. Echoing an oft-repeated refrain, Powell noted that the central bank won’t cut rates until the economic data shows inflation moving toward the Fed’s 2% target on a “sustained basis.”
When pressed further about the Fed’s redundant stance on rate-cutting, Powell noted the central bank has had a “steady hand” in achieving its dual mandate since last year. And the institution has been careful not to overreact when inflationary readings track higher or lower month to month, he added.
“The reason that’s important is that the decision to begin to reduce rates is a very, very important one because the risks are two-sided,” Powell said. “If we reduce rates too soon, there’s a chance that inflation would pop back and we’d have to come back in, and that would be very disruptive. That would not be a good thing for the economy.”
He added, “There’s also a risk that we would wait too long. In that case, that would be unnecessary, unneeded damage to the economy.”
Quelling fears about a recession, political influence on Fed decisions
With unemployment staying below 4% and strong growth in the economy, Powell said he doesn’t believe there’s an elevated risk of a recession any time soon.
Pointing to the strength in the economy, particularly in the labor market, Powell noted that forecasters see economic growth moving to 2% this year, down from 3% the year prior, which tracks (so far) with numbers in the first quarter.
“That means that we don’t need to be in a hurry to cut. It means we can wait and become more confident that, in fact, inflation is coming down to 2% on a sustainable basis,” Powell said.
With the U.S. presidential election just months away, Powell was asked whether he’s concerned about what might happen to the economy if the Fed is politicized on the campaign trail. However, Powell shut down that possibility.
“The Federal Reserve is an institution …an incredibly important American institution, especially right now because we are in that place we aspire to be. The place that transcends politics, divisive politics, and I think, in a way, we are helping hold this thing together by doing what we do the way we do it,” Powell said.
He pointed out that maintaining the central bank’s credibility on inflation and “sticking to your knitting” as critical for the nation’s economic stability.
“If people believe that you will accomplish your goals and that you won’t deviate from them for reasons like (politics), it’ll be easier to do so. And markets will react appropriately,” Powell said.
Banking system in a ‘good place,’ commercial real estate on shaky ground
As discussion turned to the banking system’s health, Powell said it was in “a good place” after a tumultuous year in 2023.
Last March, Silicon Valley Bank, one of the nation’s most prominent start-up lenders, collapsed, leading to its seizure by regulators. The ensuing panic among investors rippled out to other banks that either collapsed, had to be bailed out or were acquired by competitors.
However, the ecosystem today looks very different, Powell noted.
“I think things have settled down significantly in banks and lending,” Powell said. “We focused a lot of attention during that period and since on banks that had things like commercial real estate losses or perhaps funding structures that needed to be supported more, and we’ve worked with a ton of banks to address those issues.”
Many banks are grappling with commercial real estate losses in the wake of the Fed’s monetary policy tightening.
The central bank’s fast-and-furious rate hikes in 2022 and into 2023 pushed mortgage rates higher, increasing borrowing costs for commercial real estate loans and widening commercial mortgage-backed securities spreads, according to the International Monetary Fund. The pandemic led to a rise in remote work and online shopping, meaning there’s less demand for office and retail space and higher vacancy rates. As a result, commercial property prices have plummeted and delinquency rates on commercial mortgages are on the rise.
To make matters worse, about $4.4 trillion of commercial and multifamily real estate debt was due to mature in 2023 and 2024, with a 25% share of those being office loans, according to a 2023 report from the Mortgage Bankers Association.
Although these segment losses will mostly affect smaller banks, the “commercial real estate problem will be with us for some years,” Powell said.
