Though it was unthinkable just a short time ago, the question of what it would take the Federal Reserve to raise interest rates further is gaining increasing attention. The answer isn’t very complicated: In short, it would take not only a significant bump in prices but also a change in consumer and business expectations. Even then, central bankers likely would be extremely reluctant to tighten policy further after almost all of them have indicated that cuts are the most likely next step . Still, it’s significant that further increases are making their way back into the public conversation and the possibility is at least not being wholly dismissed by Fed officials. New York Fed President John Williams faced questioning Thursday about hiking and said he doesn’t expect that to happen, but noted that it’s always an option. “It’s not my baseline expectation now as interest rates are in a good place, and eventually at some point [we] would want to lower interest rates as the economy really gets to the 2% inflation that we’re headed towards,” Williams said during an on-stage interview at the Semaphor World Economy Summit in Washington. “Of course, you never know what could happen,” he added. “Basically, if the data were telling us that we would need higher interest rates to achieve our goal, then we would obviously want to do that.” As the leader of the New York Fed, Williams is considered one of the “Big Three” policymakers, a group that also includes Chair Jerome Powell and Vice Chair Philip Jefferson. Worries from the past The central bank has faced a run of inflation data that has shown prices are still uncomfortably high and the rate of increases is a fair distance away from the Fed’s 2% target. In recent days, multiple officials have counseled a patient, data-driven approach that indicates rate cuts anytime soon are not likely. Powell on Tuesday noted the slow progress recently in bringing down inflation and repeated that policymakers will need “greater confidence” before moving ahead with easing. Like Williams, Powell said he considers policy to be appropriate for now, even with most inflation metrics hovering around 3%. But what if inflation should not only stagnate but also move higher and push expectations up as well? “Should inflation start to reaccelerate, Chair Powell and the FOMC will have no choice but to increase rates – possibly dramatically – or risk a repeat of the 1970s,” Nicholas Colas, co-founder of DataTrek Research, said in a note Thursday. Making the same mistake as the 1970s central bank — hiking rates to fight inflation, then cutting prematurely and allowing inflation to return — is a sensitive issue for the Powell Fed. Policymakers have spoken many times about not wanting to echo past policy mistakes, particularly that one. Colas said a rate hike at this point would be “a genuine shock” that would wreak havoc by raising the cost of capital and likely tipping the U.S. economy into recession. “If inflation does start to move higher, however, they may have to bite the bullet and accept [that] harsher economic medicine is needed to achieve” the Fed’s inflation goal, he wrote. Chances are low, for now So far, only Fed Governor Michelle Bowman has given any credence to the notion of raising rates. In a speech earlier this month , Bowman said, “While it is not my baseline outlook, I continue to see the risk that at a future meeting we may need to increase the policy rate further should progress on inflation stall or even reverse.” However, in the Federal Open Market Committee’s March update of its “dot plot” grid of individual members’ rate expectations, none of the 19 members indicated rate hikes ahead and only two expected there not to be at least one rate reduction this year. Fed funds futures markets aren’t pricing in any possibility of an increase this year and only a 14.5% probability of no cuts, according to the CME Group’s Fed Watch tool as of Friday afternoon. Yet the market has had to adjust its expectations dramatically this year as the inflation data has disappointed, going from pricing in at least six cuts down to at most two. Sticky or resurgent inflation data, contrary to the steady declines seen from mid-2022 to late 2023, could always force further changes. “I don’t know that that’s a base case, but I do think [investors] need to be aware that the committee right now is saying inflation is holding in in a way that isn’t continuing that steady decline,” former Kansas City Fed President Esther George said Friday on CNBC. “Under that scenario, they are keeping all of their options on the table, including a rate increase.”
