KEY TAKEAWAYS

▶ A report Friday is expected to show inflation being slowly subdued, setting the stage for the Federal Reserve to cut its key interest rate later in the year.

▶ At the same time, consumer income and spending likely decelerated in April, according to forecasts, showing the economy's momentum weakening.

▶ Many forecasters expect the Fed to begin rate cuts in November or December, which would remove some of the upward pressure on rates for all kinds of loans.

If you're waiting for lower interest rates on mortgages and other loans, a key inflation report this Friday could be a step in the right direction—though don't expect rates to fall anytime soon.
Consumer prices, as measured by the Bureau of Economic Analysis' Personal Consumption Expenditures (PCE) measure, likely rose 0.3% in April from March, making for a 2.7% year-over-year gain, according to a survey of forecasters by Dow Jones Newswires and The Wall Street Journal. Both figures would be the same as in March, should those predictions hold.1

That could quell fears that price increases are reaccelerating, which were sparked by hotter-than-expected inflation in the first quarter.

More importantly, "core" inflation, which excludes volatile prices for food and energy, is predicted to have risen 0.2%, slowing down from the 0.3% rate in March. That's significant because officials at the Federal Reserve pay close attention to core inflation. They see it as an indicator of broader inflation trends and consider it when setting the central bank's monetary policy, which heavily influences interest rates on all kinds of loans.

Waiting for Declining Price Increases

Since last July, Fed officials have held their key fed funds rate at its highest since 2001 in an effort to cool inflation. They've been waiting for signs that price increases are headed back down to a 2% annual rate before reducing the fed funds rate.

Worse-than-expected inflation reports earlier this year threw cold water on hopes that rate cuts would come this summer, and forecasters are now focused on whether those cuts will start by the end of the year. For example, Fed Gov. Christopher Waller said last week that officials would have to see "several more months of good inflation data" before he would support rate cuts.

Fed officials have been trying to balance the need to control inflation with high interest rates against the damage those high rates are doing to the economy—and the possibility that they could slow the economy too much and start a recession.
A PCE report in line with expectations would leave the Fed on track to cut rates starting at its meeting in December, economists at Deutsche Bank said in a research note.
"Though an earlier cut is possible, it likely requires a string of more favorable inflation prints and some softening in the labor market or growth data," Brett Ryan, senior U.S. economist Deutsche Bank, wrote, along with his colleagues.  

Timing of Potential Rate Cuts

Broader financial markets are more optimistic than Deutsche Bank about the timing of potential rate cuts. As of Tuesday, traders were pricing in a 55% chance of a cut by November, according to the CME Group's FedWatch Tool, which forecasts rate movements based on fed funds futures trading data.2

The report also will include data on consumer spending and income, which could also influence interest rate decisions and serve as a barometer for the financial health of U.S. households. Forecasters are expecting personal income to have grown 0.3% in April from March, a deceleration from 0.5% the previous month, and spending to have advanced 0.4%, half the 0.8% growth rate of March. 

What Would Happen If The Federal Reserve Answered To The President?

Who should control America's money supply: the experts, or elected representatives of the people?

A long-running debate about who should run America's central bank flared up again last month after The Wall Street Journal reported that members of Trump's inner circle have passed around several proposals for bringing the Federal Reserve, with its crucial role in running the economy, more under the president's control.

Economists have said that handing the Fed's policy decisions over to a president would almost certainly lead to higher inflation. Most presidents would likely pressure the Fed to keep its benchmark interest rate lower than it otherwise would, worsening inflation.

"The evidence is pretty clear that if you give up an independent central bank you're going to get higher and more variable inflation eventually," said James Bullard, former president of the Federal Reserve Bank of St. Louis, who served on the Fed's policy committee between 2008 and 2023.

Sarah Binder, a professor of political science at Georgetown University, and an expert on how politicians influence the Fed, pointed to the "stagflation" era as a cautionary tale. The double-digit inflation and economic stagnation of the 1970s happened partly because presidents Lyndon Johnson and Richard Nixon pressured the Fed to lower interest rates, she said.

"The record of the 1970s shows that that type of political pressure helped to unleash inflation for over a decade. It's not a foregone conclusion that the Fed would bend to Trump's will, but it certainly puts the Fed in a particularly politically precarious position."

The Fed's Independence

The Federal Reserve is an unusual part of the U.S. government in that it's designed to be insulated, at least to some extent, from influence by politicians.

The Fed was established in 1913 to stabilize the financial system after a wave of bank failures, and its powers have grown over the years. It's now responsible for regulating banks and, crucially, setting the nation's monetary policy.

Congress tasked the Fed with a dual mandate in 1977—control inflation while keeping the economy at full employment. It does this mainly by manipulating the fed funds rate, which determines the interest rate at which the nation's banks lend money to one another. This influences rates for all kinds of other loans throughout the economy, including business and personal loans such as mortgages.

Decisions on raising and lowering interest rates are made by a committee that is a mix of presidential appointees who serve 14-year terms and regional bank presidents who serve one-year terms on a rotating basis.

Because the president is only ever able to appoint a handful of Federal Open Market Committee (FOMC) members during any given term in office, the committee has greater freedom than other federal agencies to operate as technocrats and make decisions based on what they deem to be wise economic policy, rather than political considerations—at least in theory.

Critics of the Fed have long sought to bring the central bank more under the control of the other branches of government. They often argue the public isn't able to hold the Fed accountable because of its independence, making its governance undemocratic. Critics have also called the Fed's economists unelected bureaucrats, saying they shouldn't be allowed to make economic policy decisions.

Why More Politics Would Lead To Higher Inflation

The Fed has been in a particularly bright spotlight the past few years as it steadily raised the fed funds rate to tame inflation that had risen far above the central bank's 2% target level. The range for the benchmark rate is currently at a 23-year high of 5.25%-5.50%, where its been since July.

The tight monetary policy has helped bring inflation down, which has led to hopes among consumers and investors that interest-rate cuts may be on the horizon. However, Fed officials have said they need more confidence that price pressures are under control before easing policy.

Economists warn a Fed that answers to the president is one that would be more likely to let inflation run rampant.

Presidents have every reason to pressure the Fed to lower interest rates and have done so in the past, partly because election cycles push them into short-term thinking, said Victor Li, a professor of economics at Villanova.

When the Fed sets interest rates extra low, loans are cheaper, people borrow more to buy more stuff, companies hire more workers, and the economy booms—all great things for a president to have happen on their watch.

"Low interest rates may temporarily lead to a lower unemployment rate, which looks great for an incumbent running for reelection," Li said in an email.
But then comes the inevitable hangover—merchants find that their customers are richer and can pay higher prices, so they raise them. Worse, because inflation is partly a psychological phenomenon, economists have found that popular belief about it can become a self-fulfilling prophecy
"Inflation is a lagging indicator," Li said. "But when it comes, it can easily spiral out of control and become hyperinflation when inflation expectations become unanchored. This is the lesson of history and it's doomed to repeat when it is not understood."

Li and other economists pointed to the example of Richard Nixon, who leaned on Fed chair Arthur Burns to keep interest rates low ahead of the 1972 election. Despite being by all accounts a respected economist who should have known better, Burns complied, helping set off the bout of double-digit inflation the country experienced in the 1970s. 

How Much Should The Fed Be Influenced?

To be sure, the Fed is not, in reality, completely removed from politics.

As Georgetown's Binder and fellow researcher Mark Spindel documented in their book, "The Myth of Independence: How Congress Governs the Federal Reserve," Fed officials do consider how their actions will be received by politicians, the public, and financial markets. Those concerns show up in transcripts of FOMC proceedings, which are released to the public after five years.

Fed officials must answer to lawmakers in Congress, who, at public hearings, frequently urge Fed officials to move interest rates in one direction or the other. Congress, however, despite having reshaped the Fed over the years, has left the final say on monetary policy up to the FOMC.

"If it came right down to it, the Congress could do whatever it wants with monetary policy, so in that sense, it is political," Bullard, the former St. Louis Fed president, said. "But Congress has looked at this over the last 100 years and decided to keep it at arm's length from the day-to-day political to and fro."

A large part of the Fed's ability to shape inflation comes from the public's belief that it will keep inflation running at its long-term goal of 2%. That could be undermined if a president were to blatantly put their thumb on the scales.

"The challenge for the Fed is its credibility, its legitimacy," Binder said. "It's all wound up in the public having confidence that the Fed knows what it's doing and that it's going to do it in a methodical way. That it's not going to simply twist in the wind, buffeted by competing parties or competing ideologies."

Binder also worries the Fed could overreact in the opposite direction, keeping interest rates too high in an effort to defend its credibility, unnecessarily damaging the economy by keeping money too tight.

Cautionary Tales From Around The World

Ian Sheperdson, chief economist at Pantheon Macroeconomics, used Britain as an example, where the central bank was under the control of the elected government until 1997. That year, the Bank of England's governing structure was changed to make it more independent.4 Not coincidentally, British inflation, which had been chronically several points higher than in the U.S. and Germany fell into line with its economic peers that year.

A study of 17 contries in Latin America by the International Monetary Fund, the financial arm of the United Nations, in 2022, found that inflation consistently ran lower in countries where central banks had more independence.5

Turkey provides another dramatic example of the link between politics and inflation. Authoritarian ruler Tayyip Erdogan tried out an unorthodox economic theory: that lowering interest rates would reduce inflation. Instead, the inflation rate got as high as 85.5% in 2023 before the central bank began using a more traditional approach, and raised rates.

Ultimately, the decision to change the Fed's structure would be up to Congress. Bullard said he sees little chance of that actually happening, based on conversations he has had with lawmakers.

"Even people that you think might be kind of more extreme, either on the left or the right, they're pretty supportive in ordinary conversation," Bullard said. "I didn't get the sense that they were seriously considering changing the structure of the Fed in a fundamental way."

Americans' attitudes toward the economy hold steady despite disappointing inflation reports

WashingtonCNN

Americans haven't felt any better about the economy these past few months, but they haven't felt any worse either. That's striking because disappointing inflation reports have thrown Wall Street into a tailspin.

The University of Michigan's latest consumer survey showed that sentiment largely held steady in April, according to a preliminary reading, edging lower to a reading of 77.9 from 79.4. Sentiment is well above the record lows seen in the summer of 2022, when inflation reached 40-year highs, though it remains below pre-pandemic levels.

"Sentiment moved sideways for the fourth straight month, as consumers perceived few meaningful developments in the economy," said Joanne Hsu, the university's Surveys of Consumers director, in a release.

"Overall, consumers are reserving judgment about the economy in light of the upcoming election, which, in the view of many consumers, could have a substantial impact on the trajectory of the economy," she added.

Meanwhile, US consumers' expectations of inflation rates remains mostly in check, ticking up only slightly in April. The Federal Reserve cares whether or not Americans have faith that inflation will eventually return to levels they're used to. Still, firmer-than-expected inflation readings did have some impact on Americans' perceptions, albeit modest.

"Greater dissatisfaction with the pace of disinflation weighed on consumers' assessments of current and future economic conditions. This is partly due to higher gasoline prices, but also the slower broader progress as seen in the recent CPI reports," Oren Klachkin, financial market economist at Nationwide, said in a note Friday.

Fading hopes for Fed rate cuts

At the end of last year, investors were full of hope that the Fed would end up cutting rates as many as six times in 2024, starting in March. Then the Consumer Price Index for January came in hotter than expected, triggering a selloff that week and pushing back the market's expectations for the first rate cut.

It was the same story for February's CPI. Then it happened again this week for the March report. Consumer prices were 3.5% higher in March from a year earlier, a much bigger increase than February's 3.2% and above what economists were forecasting. On a monthly basis, consumer prices rose 0.4%, also above expectations.

That sent a shiver up Wall Street's spine. Stocks dropped sharply after the March CPI was released Wednesday as bond yields spiked to the highest level since November. Major Wall Street banks also recalibrated their forecasts on rate cuts.

Goldman Sachs now estimates that the first rate cut will come in July, instead of June; and Bank of America now expects the first cut in December instead of June.

"We continue to expect cuts at a quarterly pace after that, which now implies two cuts in 2024 in July and November," Goldman Sachs's chief economist, Jan Hatzius, said in a note.

The economy is coming into focus

Everyday Americans, on the other hand, haven't fretted about progress on inflation potentially stalling. Still, they're not feeling any peppier about it, either.

Pessimistic moods about the economy have been a persistent headache for President Joe Biden as he campaigns for reelection. Biden is preparing a campaign swing through Pennsylvania next week to make his case for voters on how he plans to tackle economic issues.

Biden kicks off his tour through the state Tuesday with a major speech on the economy in his hometown of Scranton, Pennsylvania, campaign officials told CNN.

"The address will drive home a simple question: Do you think the tax code should work for rich people or for the middle class?" a campaign official told CNN. "The president has made it clear what he thinks the answer is, and so has Donald Trump."