Following 100 basis points in rate cuts through the back half of 2024, the Fed started 2025 with a pause, placing itself in wait and see mode for the foreseeable future.
Starting with today’s FOMC statement, there were a few language changes worthy of note. On the employment front, prior comments that labor market conditions have eased and the unemployment rate has risen, now state that the unemployment rate has stabilized and labor market conditions “remain solid.” With regards to inflation, the FOMC removed language that noted “progress towards the Committee’s 2 percent objective” and now simply state that inflation “remains somewhat elevated.” Both of these suggest more hawkishness, or at least less dovish news.
If there was one consistent theme Powell himself stressed throughout his press conference, it’s that the Fed believes their current policy stance is well positioned to respond if and when the data demand it. If the employment situation unexpectedly weakens, they stand ready to cut, but likewise they stand confident that keeping rates at current levels is enough to put continued pressure on inflation towards their 2 percent target.
It’s worth noting that the FOMC previously expressed confidence in their policy stance back in 2020 when they felt any rise in prices from massive government stimulus would be “transitory”. They also felt confident when they acknowledged that inflation wasn’t so transitory, but forecast a modest pace of rate hikes would have inflation back down to 2 percent by the time 2024 was out. Yet here we stand, continuing an inflation fight that has stalled above target, despite rate hikes that went well past forecasted levels.
And now a new battle in Washington has begun. From tax cuts and deregulation which stand to boost businesses, to a clamping down on government excess which could temporarily slow the outsized deficit spending that has propped up economic growth. We may experience pain before the gain, as the economy moves to more sustainable footing. Along the way, the Fed is likely to spend much of this year reactively, though their guideposts have proven less than reliable.
What will we be watching? If M2 growth remains modest, both inflation and economic growth will slow, and the Fed will have room to continue cuts. If, however, rate cuts (or movements by the Treasury to draw down their checking account at the Fed and put that money back into the economy) lead to a rapid rise in M2 growth, the Fed has shown an active neglect of the warning signs that would have preempted the inflation debacle to begin with.
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