Powell Sees Little Reason to “Hurry” on Rate Cuts with Economy “Strong”
- Chair Powell’s remarks today struck a notably less dovish tone than he has recently.
- This is a continuation of a gradual trend from the maximally dovish period that occurred following the July employment report until the Sept FOMC meeting, which has since seen the data and policy move in a less dovish direction (since then we’ve seen better than expected activity data; no recession validation from the labor market, although continued softening; and two ‘not good’ months of inflation).
- Highlighting this shift in the recent data, given current consensus for October core PCE and even if one optimistically assumes 2% inflation in Nov and Dec, the Fed’s 2024 core PCE forecast would need to be revised up to at least 2.8% (from 2.6%).
- On net, a 25bps cut December seems odds on but that has become increasingly tentative. My base case remains cuts in Dec, Mar, and June; all of those are modal but far from guaranteed depending on the “bumpy” inflation data and how the labor market evolves.
Powell’s prepared remarks showed a notably less dovish reaction function and reduced, but not 0, downside concern about the economy in the near-term.
As we have heard from almost every Fed speaker since the September meeting, and particularly so in the early post-Nov meeting period, Powell noted that the Fed is aiming to get policy towards a “more neutral setting.” This is a somewhat higher than many expected destination in the level of rates, particularly so as neutral rate estimates are likely to continue moving higher over coming SEPs. The path to that “more neutral” destination is “not present” and the “strength we are currently seeing in the economy gives us the ability to approach our decisions carefully.”
While the Fed was cautious in expressing downside concerns publicly in the runup to the 50bp cut in September, they were clearly top of mind. The national accounts revisions after the meeting removed two of the plausible causal stories for a recession (see more here) and since then the Fed has gradually been sounding more, although not fully so, about the outlook. Powell’s comment today that “the economy is not sending any signals that we need to be in a hurry to lower rates,” is the most impactful version of that sentiment heard so far.
Powell that he and his colleagues expect that the various inflation metrics, “will continue to fluctuate in their recent ranges.” They are at levels which are “closer to consistent” with the Fed’s target but even when slicing and dicing carefully, are not all the way there. His inflation baseline seems fairly sanguine, all things considered, “with labor market conditions in rough balance and inflation expectations well anchored, I expect inflation to continue to come down toward our 2 percent objective, albeit on a sometimes-bumpy path.” This, under a standard Phillips Curve, necessitates a view that inflation will continue to normalize towards target.
Start fast then slow down and see what the data requires had always been the appropriate baseline reaction function for the Fed. They are still likely to repay the 100-150bps of hawkish insurance they took out in 2022-23, but beyond that the case for cuts seems to require more than just the continued very gradual easing of the labor market the Fed has acknowledged (it worth remembering that the unemployment rate, at 4.1%, is notably below the 4.4% for the Q4 average they penciled in in September).
Much of the Q&A (which I found notably more informative than last week’s press conference) focused on the monetary policy impacts of the election, centered on the fiscal outlook and possible tariffs.
When asked about how the Fed would incorporate fiscal policy shifts into its outlook, Powell’s answer was more a bit informative than that at the press conference last week although the underlying takeaway remained the same. Given when things need to happen on the fiscal side, and thus when they are likely to, the economic effects of any plausible fiscal policy shifts are more likely to happen in “2026 or ’27.” He followed up by saying that “I think we have time to make assessments about what the net effects of policy changes will be on the economy before we react… that’s not to say we won’t be doing quite a lot of analysis.” Before the Fed would change its policy in response to other policy shifts (most obviously fiscal but implicitly tariffs as well), he said “I think we’ll need to have a lot more certainty.”
On tariffs, it is “not obvious” what the net effects of increased tariffs across the two side of the dual mandate will be. He noted that “retaliation, that changes the picture” and makes dual mandate tradeoffs even less clear. At time fiscal policy could be boosting the economy. The reaction to any given piece of new policy or data depends on the cycalical and structural context; “we don’t take one piece of this. We’re looking at the whole economy.” When compared to the first Trump administration trade and tariff negotiations, “we’re in a different situation… [but] we reserve judgement until we actually know what we’re talking about.”
Powell noted that with immigration inflows already slowing, the supply-side surge in labor growth and the fairly costless easing of that labor market that has come with that seems likely to abate, bringing down forward growth expectations some. His prior seems to be that the productivity growth surge over the past few years will start to fade (as he noted short-term surges in it tend to do) as much of it was likely driven by the surge in new business formation and, somewhat chaotically for employers, the surge in job quitting and the post-reopening labor reallocation boom which led to more efficient matching between workers and positions.
In one of the most interesting bits of caution, Powell seemed cautious about being too optimistic on growth on a forward-looking basis because so much of the recent strength in growth has come from the supply-side. With the labor market “still cooling,” he noted that the their mandate “is not for growth, its for maximum employment” and the labor market seems to be sending somewhat more cautious signals than does the growth data.
Given the inherent imprecision of neutral rate estimates (“there is no theoretical or empirical way to arrive at an estimate of what the neutral rate is that you can really have a lot of confidence in”) and the strength of the economy, that “argues for moving carefully.” Powell noted that you may “have to move quickly if the labor market were to begin to deteriorate… but we’re not seeing that.”
