This week the Federal Open Market Committee (FOMC) voted unanimously to keep the policy rate target range unchanged at 4.25%-4.50%. While the move was widely anticipated, there were some hawkish changes to the policy statement. Gone was the previous acknowledgement that inflation was closing in on the 2% target. Instead, inflation is now characterized as “somewhat elevated,” while the unemployment rate has “stabilized at a low level.” Federal Reserve (Fed) Chair Jerome Powell also noted (at least four times during the post-meeting press conference) that the Fed is in no rush to ease policy further given the strength of the economy and a stable labor market. When asked about the possibility of a March rate cut, Powell emphasized that policymakers want to see “serial readings” that are indicative of further progress on inflation.
Although Powell noted that the policy rate is still “meaningfully” above neutral—an indication that the easing cycle has not yet ended—he also added that the ongoing uncertainty over the true level of neutral is reason enough for policymakers to take their time with future policy adjustments. Note that the median longer-run policy rate projection in the Summary of Economic Projections (SEP) has been continuously rising for the past year amid stronger-than-anticipated economic performance and solid productivity growth. Continued economic resilience will likely continue to push the longer-run rate higher in future Fed SEPs. Our own view is that the neutral rate is closer to 4% and therefore, the scope for further rate reductions remains minimal.
On being asked about US President Trump’s new policies, Powell noted that the Fed remains in wait-and-watch mode. Moreover, given that these policies (immigration, tariffs, fiscal policy and regulation) have yet to be fully fleshed out, it would be too early to make prognostications about growth or inflation. This was, however, a slight deviation from December, when Powell noted that some policymakers had started to factor in potential government policies into their economic projections. In fact, 15 of the 19 officials in the December SEP saw a greater risk of core inflation overshooting their expectations—a massive shift from the three who felt the same back in September. Likewise, the minutes from the December meeting also confirmed that “almost all” FOMC participants saw an upside risk to inflation on the rise. Therefore, if anything, Powell appears to be more dovish than the median FOMC member.
Although slower inflation readings and/or weaker payroll data between now and March may raise market expectations for a March cut, the Fed will also be watching how broadly Trump plans to use tariffs (some of which could go into effect as early as February 1), and more importantly, to what extent these tariffs alter consumers’ inflation expectations. The 2018-2019 tariffs were relatively small, and inflation expectations were well anchored.
At the time, the Fed ended up delivering an “insurance” cut in July 2019 fearing that the potential hit to business sentiment and economic activity may well be more damaging than the increase in prices from higher tariffs. However, this time round, the starting point for the Fed is different since US President Trump has threatened much broader use of tariffs, high inflation of the last few years still remains fresh in the minds of US households and US firms continue to hold pricing power – meaning price increases are easier to pass along. In fact, the most recent University of Michigan consumer sentiment survey did show nearer-term inflation expectations moving up since November, with surveyors noting that consumers continue to express an interest in buying cars and other durables in order to get ahead of potential tariff increases.
Therefore, taking all of the above into account, we think the Fed is likely signaling a pause in its easing cycle at this point. Absent a significant weakening in the labor market and/or materially weaker inflation prints our base case is for a 25-basis-point (bp) rate cut in June. Meanwhile, markets are currently pricing in a 25-bp cut in June, along with the possibility of a second cut toward the latter half of the year.
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