Chief Economist Eugenio J. Alemán discusses current economic conditions.
This week we will have the first Federal Open Market Committee (FOMC) meeting decision on interest rates of the year, where Federal Reserve (Fed) officials are expected to leave the federal funds rate unchanged after cutting the rate by 25 basis points during the last meeting of 2024 in December. At that meeting, we also had the release of the Summary of Economic Projections (SEP) and the dot plot that indicated the Fed expected to cut interest rates twice during 2025. However, financial markets today have priced one rate cut for the entire year as the most probable outcome. No SEP will be released during this meeting of the FOMC so we will have to watch the press conference given by Fed Chairman Jerome Powell after the end of the meeting to try to pierce into what the Fed’s intentions are for the rest of the year.
If the December dot plot is still in play, and we believe it is, then the Fed chairman will probably start a campaign to convince markets of the need to stick to the two rate cuts, even in the face of the current uncertainty given the potential effects of tariffs on inflation going forward. The problem is that he would not say it in simple words, so analysts will have to interpret his comments during the press conference.
We believe Fed officials already included their tariff expectations and believed at that time, i.e., December 2024, that two rate cuts during this year were necessary to keep the US economy growing and inflation continuing its path toward the 2.0% target. However, they know that if tariffs are implemented during this year, then the path to the target will take longer. Thus, in December, they decided to extend the period in which they expect to hit the 2.0% inflation target, as measured by the PCE price index. That is: they moved their timing for hitting the target from 2026, according to the September SEP, to 2027 during the December SEP. This means that they have already baked some of the uncertainty into their expectations for inflation going forward to include the potential for tariffs.
For Fed officials, the biggest issue today is inflation expectations. The first view from the January release of long-term inflation expectations from the preliminary release of the Michigan Consumer Sentiment report was not positive. Long-term inflation expectations increased to 3.3% in the preliminary release from 3.0% in December of 2024. This was the highest rate for long-term inflation expectations since June of 2008. At that time in 2008, inflation expectations were reacting to petroleum prices of almost $134.00 per barrel compared to today’s price of about $76.00 per barrel. Thus, it is clear that petroleum prices and/or gasoline prices are not what are driving inflation expectations higher today—the main driver of the increase in long-term inflation expectations today is potential tariffs. However, today’s Michigan Consumer Sentiment Index’s final release showed that long-term inflation expectations increased somewhat but not as much as it was shown in the preliminary release early this month, to 3.2%, which was the same rate we had in November of 2024. Still high, but not as high as in the preliminary release.
It is true that December’s Fed expectations regarding tariffs as well as the potential effects on inflation could be incorrect. This means that the Fed may revise them in the coming months. However, based on current information, we believe that two rate cuts for this year are still in line with the achievement of the Fed’s inflation target of 2.0%, which has now moved to 2027.
Economic and market conditions are subject to change.
Opinions are those of Investment Strategy and not necessarily those of Raymond James and are subject to change without notice. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. There is no assurance any of the trends mentioned will continue or forecasts will occur. Past performance may not be indicative of future results.
Consumer Price Index is a measure of inflation compiled by the US Bureau of Labor Statistics. Currencies investing is generally considered speculative because of the significant potential for investment loss. Their markets are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising.
Consumer Sentiment is a consumer confidence index published monthly by the University of Michigan. The index is normalized to have a value of 100 in the first quarter of 1966. Each month at least 500 telephone interviews are conducted of a contiguous United States sample.
Personal Consumption Expenditures Price Index (PCE): The PCE is a measure of the prices that people living in the United States, or those buying on their behalf, pay for goods and services. The change in the PCE price index is known for capturing inflation (or deflation) across a wide range of consumer expenses and reflecting changes in consumer behavior.
The Consumer Confidence Index (CCI) is a survey, administered by The Conference Board, that measures how optimistic or pessimistic consumers are regarding their expected financial situation. A value above 100 signals a boost in the consumers’ confidence towards the future economic situation, as a consequence of which they are less prone to save, and more inclined to consume. The opposite applies to values under 100.
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GDP Price Index: A measure of inflation in the prices of goods and services produced in the United States. The gross domestic product price index includes the prices of U.S. goods and services exported to other countries. The prices that Americans pay for imports aren't part of this index.
Employment cost Index: The Employment Cost Index (ECI) measures the change in the hourly labor cost to employers over time. The ECI uses a fixed “basket” of labor to produce a pure cost change, free from the effects of workers moving between occupations and industries and includes both the cost of wages and salaries and the cost of benefits.
US Dollar Index: The US Dollar Index is an index of the value of the United States dollar relative to a basket of foreign currencies, often referred to as a basket of U.S. trade partners' currencies. The Index goes up when the
U.S. dollar gains "strength" when compared to other currencies.
Import Price Index: The import price index measure price changes in goods or services purchased from abroad by U.S. residents (imports) and sold to foreign buyers (exports). The indexes are updated once a month by the Bureau of Labor Statistics (BLS) International Price Program (IPP).
ISM Services PMI Index: The Institute of Supply Management (ISM) Non-Manufacturing Purchasing Managers' Index (PMI) (also known as the ISM Services PMI) report on Business, a composite index is calculated as an indicator of the overall economic condition for the non-manufacturing sector.
Consumer Price Index (CPI) A consumer price index is a price index, the price of a weighted average market basket of consumer goods and services purchased by households.
Producer Price Index: A producer price index(PPI) is a price index that measures the average changes in prices received by domestic producers for their output.
Industrial production: Industrial production is a measure of output of the industrial sector of the economy. The industrial sector includes manufacturing, mining, and utilities. Although these sectors contribute only a small portion of gross domestic product, they are highly sensitive to interest rates and consumer demand.
The NAHB/Wells Fargo Housing Opportunity Index (HOI) for a given area is defined as the share of homes sold in that area that would have been affordable to a family earning the local median income, based on standard mortgage underwriting criteria.
Conference Board Coincident Economic Index: The Composite Index of Coincident Indicators is an index published by the Conference Board that provides a broad-based measurement of current economic conditions, helping economists, investors, and public policymakers to determine which phase of the business cycle the economy is currently experiencing.
Conference Board Lagging Economic Index: The Composite Index of Lagging Indicators is an index published monthly by the Conference Board, used to confirm and assess the direction of the economy's movements over recent months.
New Export Index: The PMI New export orders index allows us to track international demand for a country's goods and services on a timely, monthly, basis.
Gold is subject to the special risks associated with investing in precious metals, including but not limited to: price may be subject to wide fluctuation; the market is relatively limited; the sources are concentrated in countries that have the potential for instability; and the market is unregulated.
The Conference Board Leading Economic Index: Intended to forecast future economic activity, it is calculated from the values of ten key variables.
Source: FactSet, data as of 12/6/2024
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