Powell Says “We Can Be a Little More Cautious” with Rate Cuts Thanks to Forecast Outperformance
- Chair Powell continued the broad theme of recent Fedspeak, including his remarks in November, noting that due to a raft of “good news… we can afford to be a little more cautious as we try to find neutral.”
- When looking back compared to the 50bps cut in September and the SEP + Dot Plot that went along with it, “the labor market is better, and the downside risks appear to be less… Growth is definitely stronger than we thought, and inflation has come in a little higher.”
- Other recent Fedspeak has generally suggested that, while the time is coming for a skip and slowdown in the pace of rate cuts, December is still likely to see a cut. Most notably, Gov. Waller said on Monday the despite the recent upside inflation surprises his forecast-driven base case remains that they cut again in Dec. Powell did not go so far in his optimism as to repudiate these views which suggest that a December cut remains odds-on but not guaranteed.
- The most natural avenue for hawkish optimism and inflation forecast uncertainty is not a skip in December but rather a continued slowdown in the pace of cuts in 2025-26 and a continued drift higher in the neutral rate.
The Fed’s general reaction function can be summed as: “we’re now on a path to bring rates down to a more neutral level over time, but you’re right the economy is strong and its stronger than we thought it was going to be in September.”
The more urgent initial 50bps cut in September happened because the Fed “wanted to send a strong signal that we were going to support the labor market if it continued to weaken.” Since then, growth has outperformed expectations, the labor market has steadied itself, and inflation has been somewhat hotter than expected.
Powell noted that “we’re not quite there on inflation but we’re still making progress.” The Fed’s rhetoric on inflation and its fairly persistent pattern of forecast misses in recent quarters suggests that they are apt to keep being mildly surprised to the upside on average going forward. By definition in most mainstream macroeconomic models, if you insist that inflation expectations are anchored and the labor market is at equilibrium you preclude the possibility of a medium-term inflation overshoot. The December SEP is likely to the 2024 core PCE forecast revised higher from 2.6% to 2.8-2.9% given the recent data. Realistically, the Fed is apt to be dual mandate indifferent to inflation so long as it appears to be durably below 2.5%, if there not other signs of the economy or labor market reheating.
On tariffs, Powell made clear that “we don’t know” nearly enough about the timing, scope, duration, composition, or potential pass-throughs of any potential tariff policies in order for them to be impacting Fed policy at present. But the staff is working on analyzing various plausible scenarios. Despite the first-order inflationary impacts of tariffs, he noted that any possible response, even if you knew all the above, is something they cant make policy in advance of because “the main thing we don’t know is all the other things that will be happening in the economy.” That policy impacts are state dependent is a key lesson and forecasting principle for the Fed, and others in the macroeconomics business, across possible new administration policies.
Powell’s comments around immigration suggest that the disinflationary supply-side driven growth surge (due to immigration and productivity growth) of the last two years is likely to fade somewhat going forward. The surge in immigration, which has slowed notably over the past 6 months, was a key “part of why GDP growth was so high in 2023 was a wave of people coming and doing more work and spending money.” The fading of this positive supply-side shock to the labor market will over time slow trend, or non-inflationary, NFP and GDP growth (already slowing notably due to slower hiring intentions and openings), although the initial impact is more likely to show up in measures of labor market slack starting to gradually retighten.
