by Kathy Jones, Head of Fixed Income, Charles Schwab and Company
The Federal Open Market Committee (FOMC) paused rates today at its January meeting, ending a string of three cuts in a row late last year. The decision was no surprise, and markets are priced for steady policy the next few months as inflation remains above target and unemployment is low despite the slowdown in hiring. Moreover, financial conditions are loose and there are few signs of stress in the financial system.
There were two dissents. Both Governor Stephen Miran—nominated by President Trump last year—and Governor Christopher Waller, under consideration for the Fed chairmanship, favored a quarter-point cut. All this year's new voting members favored a pause.
Fed sounds more upbeat on economy
In its accompanying statement, the Fed indicated that it kept the federal funds rate—the rate that banks charge each other for overnight loans—in a range of 3.5% to 3.75%. The statement contained only a few changes but left the door open to rate cuts later this year.
The two notable changes in wording were that economic growth was described as expanding at a "solid pace" compared to a "moderate pace" in the prior statement, and the unemployment rate was described as having "shown some signs of stabilization." Previously, the Fed had referred to unemployment having "edged up." Coming into the meeting, it was largely expected that the statement would not change that much.
Powell avoids controversy in press conference
With the rate decision baked in before the meeting, the real focus today was Fed Chairman Jerome Powell's press conference. Powell's term ends in May and a replacement could be announced any day. Also, Powell has faced intense criticism by President Trump and is under a federal criminal investigation.
In his press conference, Powell declined to address questions about his January 11 video response to the announcement of a criminal investigation against him related to cost overruns on a Fed headquarters renovation project and wouldn't say if the Fed had responded to subpoenas. He also deflected a question about whether he'd remain as Fed governor after his term as chairman ends. "There's a time and place for these questions," Powell said. "It's not something I'm going to get into today."
In response to questions about the rate path after the three cuts late last year and the pause today, Powell said, "We do think we're well positioned after those three cuts to let the data speak to us." He expects to make decisions meeting by meeting and said there was broad support at the FOMC for a pause today. Upside risks to inflation and downside risks to employment have both "diminished a bit," he added.
Getting there from here
The futures market prices in little likelihood of a rate cut until June—coinciding with the first meeting chaired by Powell's replacement. By our estimates, the fed funds rate is on the low side of where it should be based on the strength of the economy, resilience of inflation, and financial conditions. Allowing for some decline in inflation and inflation expectations, the 3.5% level seems reasonable. In fact, the evidence indicates that it is not holding back economic activity or borrowing.
The decision to hold steady reflects a lack of reason to cut, though December's "dot plot" of rate projections did work in one cut this year. The Fed likely reasons that economic growth is strong at around 3.5% to 4%, there's fiscal stimulus ahead, inflation is closer to 3% than the 2% target, the dollar is softening, financial conditions are very loose, and unemployment is low.
In light of that, there's no logic for a cut unless you believe that either the economy or inflation is going to slow significantly. Miran reasoned that the neutral rate is lower than the Fed currently believes, but empirical evidence suggests it is not. The current level of rates is not a constraint on the economy.
The Fed is likely to tread cautiously given the economic backdrop.
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