January FOMC Doesn’t Give Us Much New
- As has often happened, the press conference was somewhat more dovish than the statement. Chair Powell framed most of the mildly hawkish changes to the statement as basic factual and linguistic updates rather than forward-looking policy signals.
- To see further cuts, you are “going to want to see inflation behaving in such a way that it builds confidence” in the eventual return towards 2% target inflation.
- The Committee seems divided between those who think we are quite close to neutral and those who think there should be a stronger presumption towards some further easing due to a lower neutral rate. The data has favored the former group, but I would guess that Chair Powell remains in the latter.
- After seeing some placeholder tariff and fiscal policies added to the Dec SEP, and moving the dots higher, Powell seemed determined to deemphasize these risks as current drivers of policy.
- Regarding a possible March cut, Powell said that that “broad sense of committee is that we’re not in a hurry to adjust policy stance.” This was more definitive than I would have expected but Powell then noted that “we’re ok with March staying near the table but it doesn’t have to be on it.” In other words, realizing a March cut likely requires a bit better than expected inflation data, or more unexpected softening in the labor market. It certainly has some chance, just a bit less than I’d have guessed.
On net, the day: suggested somewhat lower odds of a March cut, highlighted Powell’s relative dovishness, emphasized the wide range of views on how restrictive policy is, and reminded of the challenges for communicating, let alone implementing, monetary policy around possible but highly uncertain tariff and fiscal policy shocks.
The near-term policy outlook can be summarized by Powell’s most hawkish comments of the day that, “we will be focusing on seeing real progress on inflation, or some weakness in the labor market before we consider making further adjustments” to the stance of policy. Most of the rest of the press conference though took a more centrist or even at times outright dovish tone.
Three parts of Powell’s framework stood out to me in a somewhat dovish way, despite his near-term patience on rate cuts and the tweaks to the statement.
- “At the end of the day it comes down to 12-month inflation.” This allows for quite likely progress over the next few months (“we seem to be set up for further progress”) but also suggests that there remains some residual scarring of the Q1 excess seasonality issues (actually “having it is another”) on the part of the FOMC.
- Powell views the neutral rate as “meaningfully” below the current level of the fed funds rate. Not a real surprise and there was at times a tension between his near-term patience and longer-run views on neutral.
- Despite the cat getting out of the bag with the December SEP and Dot Plot, Powell seemed determined not to preemptively respond to (outright or through more inertial and cautiously hawkish policy), as opposed to plan for, tariff and fiscal policy risks at this point in the process.
Powell’s framing of the labor market was one of the more interesting and consistently more optimistically hawkish aspects of the press conference. While the jump higher in the unemployment rate over the summer clearly spooked the Fed, Powell’s descriptions today were quite benign. He said that “the labor market does seem to be pretty stable and broadly in balance… you’ve got an unemployment rate that has been pretty stable now for a full half year.” His anchoring to the unemployment rate as the best single indicator for the labor market is not particularly surprising, Yellen said the same after all as well, but it still imparts a bit of an optimistic skew to their outlook. This stands in mild contrast with the continued moves lower in the hires and quits rates (and very small increases in the level of continuing claims). His least optimistic comments on the labor market did note the low hiring rate, “if there were to be a spike in layoffs you would see the unemployment rate go up pretty quickly because the hiring rate is quite low” but he quickly noted that the levels of slack in the labor market are “good.”
I don’t think the labor market is rapidly deteriorating but Powell’s focus on current levels of slack and topline NFP growth, rather than its relatively acyclical composition, could open them up to an analytic error down the line if things continue easing notably further.
This overall labor supply-demand balance, despite odd internals, means that “the labor market is not a source of significant inflationary pressures.” This has been a recent consistent refrain of Powell’s but also means that residual inflationary pressures would be due to supply shocks (commodity prices, tariffs, etc), deanchoring expectations (Powell didn’t want to go there), or increasing persistence in inflation’s pace of normalization.
The Committee seems divided between those who think we are quite close to neutral and those who think there should be a stronger presumption towards some further easing. The data has favored the former group, but I would guess that Chair Powell remains in the latter. Those making more dovish, and presumably lower neutral rate-based arguments, have been using language similar to this, focusing on rates sensitive parts of the economy, saying “our eyes are telling us that our policy is having effects on the economy… and we see that its having meaningful effects in bringing inflation under control” but that seems somewhat inconsistent with the topline activity data. There is a tension here between Powell’s framing of the stabilization in the labor market and overall economy and insistence that “we are meaningfully above [neutral]… but it’s appropriate that we not be in a hurry” to return to a neutral policy stance.
Perhaps the way to square the above issues is that Powell sees the impact of above neutral policy rates as acting less on overall economic activity and growth rates but more on sluggish hiring rates, which have not been a problem due to low layoff rates[1] and a decreasing flow of immigration reducing labor supply growth.
Despite the tweaks to the core PCE forecasts in December, the move higher in the Dots, and some Fedspeak opening the door to discussing tariffs more freely, Powell seemed to want to avoid the subject as much as possible. Analytically his comment that “we don’t know what’s going to be tariffed. We don’t for how long or how much. We don’t know what countries. We don’t know about retaliation. We don’t know how it’s going to transmit through the economy to consumers” is certainly fair enough but it gives us no effective guidance as to the Fed’s likely reactions to any eventual policy shocks. This may reflect a desire not to bring unwanted political heat on the Fed or a view that the possible impacts are so initial conditions dependent it doesn’t really bare talking about now when the range of policies is so broad.
The tweaks to the statement were probably correctly worth a few bps higher in rates but its hard to take them as a particularly strong signal, particularly after Powell’s comments deemphasizing them. The update of the labor market language to stating that the “unemployment rate has stabilized” and that “labor market conditions remain solid” suggests that the Fed is losing the most urgent dovish pull towards lower rates with that half of the mandate seemingly ok in their view. There may still be some broadly need to adjust rates a bit closer to neutral in order to preserve that stability but that would be a more gradual process (as everyone expects and the Fed already telegraphed in December). On inflation, the Fed removed the language about recent progress towards 2% and just noted that, in perhaps the briefest statement they could make which would also be obviously correct, “inflation remains somewhat elevated.”
Layoff and hiring rates are both endogenous to demand but hiring rates tend to lead demand restraint more than layoffs which lag so perhaps Powell’s take on restrictiveness is appropriate, but it makes his sanguineness on the broader labor market a bit more challenging to interpret. ↑
