The Fed Will Continue to Be Data Driven

The Fed Will Continue to Be Data Driven

• In the very near term, the election seems unlikely to notably change the Fed outlook. Afterall, as Powell has repeatedly emphasized, they will continue to aim for their dual mandate goals in a data and risk management dependent way. Farther out in the medium-term the Fed will need to see more concrete fiscal, tariff, and immigration plans in order to incorporate them into its baseline outlook and make reasonable risk management inferences about them.
• At the press conference tomorrow, Powell will do all he can to avoid commenting on the politics of the election and (re)emphasize the dual-mandate centric message above.
• The Fed still think the setting of policy is notably above neutral (in the September dot plot the median was 2.9% nominal, likely to keep drifting higher, with a 2.4-3.8% range), inflation has improved substantially but is still somewhat too hot, and the labor market risks are skewed to the downside even if the likelihood of a near-term recession is notably lower than it was 6-12 weeks ago.
• My baseline remains that the Fed will cut 25bps in November (tomorrow), December, March and June before going on an extended pause. Of those meetings, a June skip seems most likely and the one most likely to be impacted by Trump administration policy, with December as a possible skip as well depending upon how the November employment report rebounds from the October whiff and the Oct-Nov inflation data. This is now fairly close to market pricing.
• Longer-term rates, 10y yields up 19bps at present, will serve as a natural counter-cyclical force, moving, as they have, in response to 3-6m long mini-cycles of data surprises and misses. This built-in cyclical governor takes some of the Fed’s work away from it.
• Assuming, and it is not obviously a done deal yet given October’s employment report, that Sahm Rule-like concerns of more acute labor market weakness do not come to pass then the economy’s baseline path into 2025 looks solid. Of course, largescale immigration, tariff, or geopolitical shocks could disrupt that outlook but the endogenous baseline continues to look solid with many cyclical headwinds turning more neutral or outright supportive as we move into 2025.
• It will take time for the new administration’s policies to solidify more appreciably, then to be enacted, and then to filter into the data. This isn’t to say that the Fed won’t react to policy announcements and the broad contours of policy but that reaction needs to be premised on something fairly concrete and close to implementation or enactment rather than selective read-throughs of, often conflicting or inconsistent, campaign promises.
• Tariffs are a classic supply shock, dinting activity while raising inflation. Typically, monetary policy is limited in its response to supply shocks (oil price movements being the most common example) concerning itself primarily with second order impacts given most supply shocks’ one-off price-level, rather than medium-term rate of inflation, shift impact. Given the legacy of high inflation and an economy which is close to a neutral position, depending a bit upon where you look in the growth and labor market data, the likely pass-throughs from tariffs into prices will likely be somewhat higher than in a weaker economy and the Fed more concerned about more persistent second round impacts. Still, moderately sized tariffs are likely to see some response even if it is, in the first order, only in truncating away some more dovish possibilities.
• Immigration policy is also a potential negative (i.e. inflationary) shock the Fed may have to contend with as well. Actions to crimp the flow of immigration would be a slow drag on potential growth, gradually retightening the labor market while large scale deportations (or enough of them to shift workers into a lower labor participation rates) would be a more immediate spot impact, both of which would retighten labor markets. Immigration flows have already slowed notably regardless, so the short-term NFP trend consistent with a flat unemployment rate is likely to be gradually downshifting anyway.
• Fiscal policy looms more directly impactfully on the 2025H2 horizon given the pending expiration of much the personal side of the 2017 TCJA. Trump’s announced plans are widely seen as more deficit expanding than Harris’ were, although the extent of deficit expansion available and aimed for remains to be seen. Realistically, assuming the economy evolves broadly in line with expectations out to 2026, the likely multipliers on any stimulus above current policy (distinct from the usual current law baseline more commonly referenced in DC) will be fairly close to 0 given the limited ability of procyclical policy, especially that targeted at lower MPC households, to stimulate demand when it is above supply thanks to rate, whether policy or LT, and FX offsets as well as short-term supply constraints.
• It remains to be seen if Powell serves out the rest of his term but my very tentative suspicion is that he will. Who Trump appoints next as the Chair remains quite uncertain and will be one of the key debates for markets to watch in 2025.
• I am skeptical that any of the other Bidan appointees will resign early, meaning that the Board will continue to have a fairly dovish makeup on net but how much that matters given the Fed’s usual Chair-deference on monetary policy matters remains to be seen (it’s a possibility worth entertaining that the Fed could implicitly move more towards a median voter model like the BoE if Trump appoints a more extreme or clearly partisan Chair but that’s long way from being top of mind).
• It is unclear how hawkish a Fed chair Trump would really want. Yes, inflation was clearly a very winning issue for him, but Trump has historically been more a low rates guy (the background in RE clearly has a lean here), is fairly stock market sensitive, and may see himself as cleanly separated from the post-covid inflationary shock. Given that the baseline outlook is for solid growth and inflation noisily a bit above target this may not end up mattering too much, barring a recession or notable inflationary resurgence.