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Fed confronts raging inflation as markets melt down

Federal Reserve officials could stick with their original plan for a half-point rate increase and risk being seen as too timid on inflation. Or they could go with a heftier hike, which could be taken as a sign that the situation has grown more dire.

Federal Reserve chairman Jerome Powell spoke to reporters in May after the central bank raised interest rates by one-half point, the most since 2000. He is scheduled to hold news conference on Wednesday following the Fed's next rate decision.Al Drago/Bloomberg

No surprises.

That’s been Jerome Powell’s goal as chairman of the Federal Reserve. There have been occasional missteps, like his abrupt pivot to cutting interest rates in 2019. But for the most part, Powell has successfully given financial markets ample notice of the central bank’s moves.

Such was the case in the leadup to this week’s two-day Fed meeting, with everyone on Wall Street and their mother expecting officials to continue their inflation-fighting campaign with a half-point boost to the benchmark federal funds rate, to the range of 1.25 to 1.5 percent.

But that consensus crumbled on Friday, when the Labor Department said that consumer prices in May rose at the swiftest rate since 1981. The report, which was worse than most forecasts, triggered furious speculation that the Fed would instead push rates up by three-quarters of a point, and perhaps more.

Now, as Powell and his colleagues on the Federal Open Market Committee wrap up their meeting on Wednesday, they’re confronting a Catch-22.


FOMC members can stick with the original plan, and risk being seen as too timid in the face of raging inflation. Or they could go with a heftier hike, which could be taken as a sign that the situation has grown more dire. Moreover, breaking with their widely telegraphed half-point increase would undermine confidence in any subsequent Fed guidance.

“The Fed losing credibility on its forward guidance would be a high price for one day with unexpectedly bad data,” said Claudia Sahm, a consultant and former Fed and White House economist, referring to Friday’s inflation report.

While Sahm thinks the Fed will opt for the larger increase, Brian Bethune, an economist at Boston College, said he expects a half-point move.


“They don’t like to surprise the market,” Bethune said. “The financial markets are in stress. The Fed doesn’t want to make it any worse than it already is.”

Stocks entered a bear market on Monday, bond yields are surging, and the crypto market has crashed.

The essential question, of course, is whether the Fed can rein in inflation without shoving the economy into a recession.

Higher fed funds rates flow through to consumers and businesses in the form of steeper borrowing costs on everything from mortgages, credit cards, and car loans to corporate bonds. The intention is to reduce spending, thus relieving pressure on prices. The danger is that consumers, whose spending accounts for nearly two-thirds of the economy, retrench too deeply, leading to a downturn and rising unemployment.

On Friday, the University of Michigan’s survey of consumer sentiment showed respondents expect inflation to run at 5.4 percent over the next year. The Fed’s longer-term target is 2 percent.

Based on futures trading, investors see a 0.75 percentage-point increase on Wednesday, and again at the FOMC meeting at the end of July. The Fed hasn’t bumped up rates by that amount since 1994. Just a week earlier, investors were betting on a half-point rise on Wednesday and in July.

Rates on US Treasuries have spiked higher in recent days; another sign investors expect the Fed to get more aggressive. The yield on the 10-year note hit 3.48 percent on Tuesday, up nearly half a percentage point in five trading days. The 10-year yield was under 2 percent as recently as mid-March.


The Fed’s decision will be announced at 2 p.m. on Wednesday, along with its latest forecasts for economic growth, employment, and inflation.

Powell is scheduled to hold a news conference 30 minutes later.

Investors will carefully parse his statements and the central bank’s new economic projections to discern how high interest rates and unemployment might rise, and how quickly inflation might recede.

“Powell is likely to be pushed on whether he still thinks the Fed can get inflation under control without causing a recession,” Sahm said. “And, relatedly, would he be willing to put the economy into a recession if that’s what it took?”

Larry Edelman can be reached at larry.edelman@globe.com. Follow him on Twitter @GlobeNewsEd.