Fed can send a big message this week with a small bump in key interest rate

How can a smaller move send a big message? That’s the dilemma the Federal Reserve finds itself in as it meets this week to discuss its a target short-term interest rate.

There’s no doubt the central bankers will raise the borrowing rate for the eighth consecutive meeting in the ongoing effort to tamp down generational-high inflation. And there’s no doubt on Wall Street they will hike rates by one-quarter of 1%, according to the CME FedWatch Tool.

Such a “small” rate increase after much more aggressive changes comes with some big questions, though.

Should investors take it as a sign of confidence by the Fed that its inflation fight is winding down?

Does a lighter touch now risk having to return to an intense inflation fight in several months?

How does easing its aggressive stance toward inflation affect the Fed’s reputation?

The seven previous rate hikes — most of them at a pace not experienced in decades — have yet to be fully integrated into the broad economy. Certainly, home sales have slowed as mortgage rates have shot up. Wage growth is slowing. And announced layoffs have become almost daily headlines in the technology and financial industries.

Yet, two weeks ago Federal Reserve vice chair Lael Brainard — a leading candidate to become President Joe Biden’s top economist — told a University of Chicago business school audience, “It is likely that the full effect on demand, employment, and inflation of the cumulative tightening that is in the pipeline still lies ahead.”

Stock market investors have been encouraged by the possibility of a less aggressive Fed. Mortgage rates may drop to help support housing. Consumer confidence may be buoyed by inflation pressures easing. And visibility into business conditions six months or more ahead may encourage businesses to keep hiring.

Investors also have been worried by a less aggressive Fed. Inflation is far from whipped. Why should the central bank be right about inflation now, when it was wrong on inflation on the way up? And if inflationary forces aren’t cured, a second surge would prolong the economic tourniquet of rising interest rates.

The Fed’s decision this week is a big one, even if it’s a small move.

Tom Hudson is a financial journalist in Washington, D.C. He’s chief content officer at WAMU public radio station.

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