Fed Holds Rates Steady Amidst Shifting Economic Landscape
The US Federal Reserve’s Open Market Committee (FOMC) has once again opted to maintain the federal funds rate within its current target range of 3½% to 3¾%. This marks the second consecutive meeting where policymakers have decided against an immediate rate adjustment. While the majority favoured holding steady, the January meeting saw two members advocating for a rate cut, a sentiment echoed by one member in the latest deliberations.
However, internal policy models, such as those developed by CCI, suggest a more hawkish stance might be warranted. These models, which take into account the Fed’s economic projections and estimates for the neutral federal funds rate and the Non-Accelerating Inflation Rate of Unemployment (NAIRU), indicate that the federal funds rate should ideally be higher, sitting around 4%.
The rationale behind these higher suggested rates stems from persistent core inflation figures that remain significantly above the Fed’s 2% target. Furthermore, many estimates for the neutral policy rate are now exceeding the FOMC’s median projection of approximately 3%. This divergence occurs even as signs of slack in the labour market emerge, with employment growth showing a prolonged period of sluggishness and the unemployment rate nudging above NAIRU estimates.
Official Fed Outlook vs. Emerging Realities
Officially, the FOMC’s updated economic outlook still projects one rate cut for the current year and another for the following year, a forecast that has remained consistent since December. This forward-looking trajectory is largely predicated on the assumption that the inflationary impact of tariffs will diminish as the year progresses, coupled with ongoing concerns about the subdued pace of job creation.
Despite this official stance, the economic ground appears to be shifting. Slower-than-anticipated progress in curbing inflation, combined with the fresh geopolitical threat posed by the conflict in Iran, is creating new uncertainties.
The “Two-Sided Guidance” Debate
During a press conference, Fed Chair Jerome Powell addressed questions regarding whether some FOMC members had again expressed a desire for “two-sided guidance” on monetary policy. This term, while perhaps sounding technical, essentially refers to the possibility that the next move in interest rates could be either an increase or a decrease. Powell confirmed that the prospect of a rate hike as the next move was indeed discussed at the meeting, mirroring discussions from the previous session. He acknowledged that while the vast majority of participants do not view this as their primary scenario, the Fed remains open to all possibilities.
“The possibility that our next move might be an increase did come up at the meeting, as it did the last meeting,” Powell stated. “The vast majority of participants don’t see that as their base case, [but], of course, we don’t take things off the table. But you correctly characterised … what was in the [January] minutes, that several participants indicated something very much like that conversation did happen.”
Geopolitical Shocks and Inflation Expectations
Regarding the conflict in Iran, Chair Powell was notably cautious, emphasizing the considerable uncertainty surrounding its duration and its potential ramifications for prices and consumer behaviour. “Like everybody else, we have to wait and see what happens … [and] I really wouldn’t speculate,” he commented.
However, Powell did elaborate on the traditional central bank approach of looking through energy price shocks. He clarified that this strategy is contingent on inflation expectations remaining stable. He highlighted that the persistent inflation exceeding the target for five years has been a significant factor influencing the FOMC’s decision-making process.
Historically, inflation expectations have demonstrated remarkable stability, weathering both the prolonged period of low inflation post-global financial crisis and the inflationary surge during the pandemic. Nevertheless, all central banks are acutely aware of the lessons learned from the 1970s, where substantial and sustained energy shocks contributed to entrenched higher inflation expectations, ultimately leading to a detrimental combination of high inflation, elevated unemployment, and soaring interest rates.
Leadership Transition and Ongoing Investigations
In a separate development, Chair Powell indicated that his tenure as Fed Chair might extend beyond the anticipated handover to former Fed governor Warsh in mid-May, should Warsh’s Senate confirmation be delayed. He pointedly added that he has “no intention of leaving the board until the [Department of Justice] investigation [into him and the Fed] is well and truly over with transparency and finality.”
Furthermore, when questioned about potentially serving as a governor after his term concludes and the investigation is resolved, Powell stated that he had not yet made a decision but would base it on what he believes is best for the institution and the public it serves.
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