Monetary Policy & Inflation | US
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Summary
- The Fed held rates as expected with its economic assessment and policy outlook unchanged, though a lack of details on the Trump administration’s policies has created unusual uncertainty.
- Chair Jerome Powell expects the immigration decline to continue and lead to a combination of lower job creation and continued labour market balance.
- Powell’s presser and President Donald Trump posting on Truth Social suggest the Fed and administration are establishing an uneasy collaboration.
Market Implications
- I still expect no cuts in 2025 against the markets pricing about 1.9 cuts.
Fed on Hold as Expected
As expected, the Fed remained on hold with no dissenters. The meeting broadly played out as I expected (i.e., the base case in our Fed scenarios note).
The economic assessment was unchanged, Powell stressed. A somewhat hawkish tilt to the statement was offset by Powell mentioning during the presser, ‘two good inflation readings in a row’ as well as shelter disinflation and the impact of inputed prices.
The Fed assessment remains that activity is expanding at a solid pace (Powell underplayed growth by saying 2024 GDP had risen ‘above 2%’ when it is likely to print near 3%); labour market conditions remain solid; and inflation remains ‘somewhat elevated relative to the Fed target’ (Chart 1).
Unchanged Policy Outlook
Powell repeated that actual inflation progress would be needed for further cuts. When asked to explain what this might consist of he said ‘we will know it when we see it’ (the Summary of Economic Projections expects two cuts this year and a 30bp slowdown in core PCE).
He described the policy stance as ‘very well calibrated’ and explained once more that, since R* could not be ascertained in real time through models, you ‘had to just look out the window and see how your – how your policy rate is affecting the economy. And I think we see that it’s having meaningful effects in bringing inflation under control.’
He downplayed the risks of a March cut by stressing the economy was strong and inflation stable and therefore the FOMC ‘doesn’t need to be in a hurry to adjust its policy stance.’
When asked about the impact of the recent tech sell off, he stressed the tightening of financial conditions would have to be persistent to have a macroeconomic impact and therefore an impact on Fed policies.
Powell continued stressing too little was known about the administration polices, especially with regarding tariffs, immigration, fiscal policy, and deregulation, to assess their macroeconomic impact. He admitted this lack of details had created unusual economic uncertainty.
Powell also indicated that quantitative tightening would continue apace and the Fed would soon start its five-years review of its policy framework.
Overall, this was a neutral meeting and since three of the four latest speakers (Cook, Kugler and Waller) have been more dovish than Powell, Macro Hive’s Fed LLM Sentiment Index could rise (Chart 2).
Powell Expects Lower ‘Break Even Employment’
When asked about the impact of the mass deportations of illegal migrants on inflation and labour supply, Powell answered so far only anecdotal evidence was available and deportations had yet to show up in the aggregate data.
He mentioned the inflow of migrants had come down ‘very significantly’ and there was ‘every reason to expect that to continue.’ He saw this decline as contributing to the recently slower job creation and to the unemployment stabilization. Furthermore, due to lower immigration, the employment growth needed to balance the labour market had decreased.
These comments suggest the Fed may not ease in response to slower employment growth if the central bank believes this reflects slower labour supply, which has been my view for some time.
Uneasy Collaboration With Administration Begins
Throughout the presser, Powell avoided talking about the administration policies in any way that could be construed as criticism. He stressed there was too little information to assess the macroeconomic impact of these policies.
While he acknowledged the context for the tariff increases differed from 2019 (this time there was a recent episode of high inflation and inflation was above target) he stressed this could play out positively or negatively.
Powell has been trying to minimize sources of friction with the administration that do not impinge on monetary policy independence. On 17 January, the Fed withdrew from the Network of Central Banks and Supervisors for Greening the Financial System (NGFS). During the presser, Powell explained this was due to changes in NGFS’s agenda.
Powell was also asked whether the Fed would continue its commitment to Diversity, Equity and Inclusion after the recent executive orders banning these within the civil service. He replied, ‘as has been our practice over many administrations, we are working to align our policies with the executive orders as appropriate and consistent with applicable law.’
By contrast, Powell again strongly affirmed the independence of monetary policy from the administration. He stressed ‘lots of research shows that’s the best way for a central bank to operate.’
Trump’s Truth Social posting soon after the presser suggests he has made peace with monetary policy independence. Trump stated, ‘because the Fed failed to stop the problem they created with Inflation’ he would do so himself through deregulation, lower energy prices and a stronger supply side. Also, Trump announced the Treasury would take over bank regulation and supervision from the Fed and implement deregulation, which has been my expectation.
I expect Powell to soon meet Secretary Scott Bessent, aligning with his practice of holding regular meetings with the Treasury Secretary.
Market Consequences
The FOMC did not materially change my conviction on no 2025 Fed cuts that is largely based on expectations of sticky inflation. By contrast, markets are still pricing about 1.9 cuts in 2025, although they have lowered the risk of a March cut to about 20% from about 30% before the FOMC.