Powell Eases Up on the Brakes As Economy Cools

Article originally posted on CoStar on February 2, 2023

Fed Downshifts To Make Smallest Rate Increase in Its Last Seven Meetings

Federal Reserve Board Chair Jerome Powell speaks during a news conference at the Federal Reserve in Washington, DC, on February 1, 2023. (Getty Images)
Federal Reserve Board Chair Jerome Powell speaks during a news conference at the Federal Reserve in Washington, DC, on February 1, 2023. (Getty Images)

The frontloading of interest rate hikes appears to be coming to an end as the Federal Reserve’s policy-setting committee downshifted its policy rate increase on Wednesday to 25 basis points, or one-quarter of a percentage point, the smallest increase in seven meetings.

Recent data show the economy is slowing in response to the central bank’s aggressive policy tightening program that added 425 basis points to the target rate in 2022.

The decision sets the overnight lending rate for banks to between 4.5% and 5.0%, its highest level since December 2007, the eve of the Great Recession.

The committee’s statement recognized the downshift and revised its language regarding future rate hikes, referring to the “extent” rather than the “pace” of increases to come, signaling that any increases to come would also be of 25 basis points.

Earlier expectations were that the Federal Reserve would push rates higher by 50 basis points in their first meeting of this year, but more recent data have suggested a weakening of economic conditions.

The economy grew in the fourth quarter by 2.9% (annualized), according to the Commerce Department, following upwardly-revised third quarter growth of 3.2% — both above trend. However, analysts have pointed out that the major factor of the positive reading of economic growth was a build-up of inventories following a modest holiday shopping season, and a decline in the trade deficit, both of which are unlikely to be repeated, suggesting that underlying growth in the economy was flat or slightly negative after two earlier quarters of negative economic growth.

Consumer spending, according to a separate report, slowed in November and December, a risk to the economy as household spending drives more than two thirds of the economy. Factory output also slowed in the final months of 2022, broadening the slowdown and providing some justification for smaller rate hikes.

In his post-meeting press conference, Federal Reserve Chairman Jerome Powell noted that inflation, while easing, remains elevated and that the committee will need “substantially more” evidence that prices are on a path to be sustainably at or below its 2% target rate before the tightening cycle will end, noting that the committee did not perceive that monetary policy was at a sufficiently restrictive stance to achieve that target and that “we will stay the course until the job is done.”

Asked about the persistence of this tightening cycle and its impact on the commercial real estate market, Chad Littell, CoStar’s National Director of Capital Markets Analytics, commented that this should further slow transaction activity in 2023 by placing upward pressure on both cap rates and borrowing costs. “Refinancing risk is now a growing concern among investors that face near-term loan maturities in a climate of slowing tenant demand,” he said. “Moreover, with muted rent growth ahead, higher cap rate requirements will likely have a negative but delayed impact on asset prices across property types.”

Powell faced several questions about inflation already falling, especially more recently, and was asked if the committee would pause additional action until the full effects of the aggressive tightening cycle have had a chance to cycle through the economy.

In response, Powell noted that the disinflationary process was indeed beginning but was yet an early stage, pointing out that the easing of supply chains and the transition of consumer spending from physical goods to services was indeed allowing inflation to fall in the goods sector.

He further commented that while prices of housing services are still rising these are expected to moderate as leases roll over. However, inflation in the services sector outside of housing, which accounts for 60 percent of the price index and which is more reliant on labor, is not showing signs of disinflation yet.