December FOMC Minutes

Stephen Stanley | January 8, 2025

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

There were not many surprises in the December FOMC minutes.  The bigger story is what was not said.  Just to set the context, it was only a few months prior that Chairman Powell and the FOMC had totally misread the economic situation and panicked, concluding that the labor market was on the cusp of potentially deteriorating substantially and that, on the back of just three decent monthly core PCE readings, inflation had been brought to heel.  Thus, the Fed slashed rates by 50 basis points in September and financial markets quickly concluded that more aggressive easing moves were possible going forward.

It would not be unfair to say that in the wake of the Fed’s September decision, virtually every key economic indicator for the next month or two was significantly stronger than expected, encompassing employment, inflation, consumer spending, and even the annual benchmark GDP revisions.  It quickly became clear that the 50 basis point move in September had been unnecessary, and Fed officials soon acknowledged that subsequent moves would be only 25 basis points.

By December, the FOMC was facing a very different economic landscape.  Though Powell and company are not allowed to talk about politics, the election results boosted business confidence and seem to point toward higher growth as well as higher inflation (mostly due to tariffs) over the next few years.  The changes in the FOMC economic and policy forecasts from September to December were extensive but a bit puzzling.  Economic growth turned out to be noticeably higher in 2024 than expected in September (the median FOMC projection increased by half a percentage point).  A similar adjustment was made for 2024 inflation (0.1 percentage points for headline PCE and 0.2 percentage points for core PCE).  But, aside from a sharp upward adjustment to 2025 inflation estimates (up four tenths for headline PCE and three tenths for core PCE), which I suspect is mainly predicated on the prospect of tariffs, the outlook was not altered by much.  Projections for growth and unemployment over the next three years were barely changed, and inflation forecasts, after 2025, got back to essentially in line with the 2% target in 2026 and 2027.  That profile would seem to be consistent with a little changed policy outlook relative to September.  However, the median dot pointed to two quarter-point cuts in 2025 (down from 4 in September), with the median 2026 dot also 50 basis points above the September level.

Let’s go back further.  In December 2023, the FOMC projections called for 1.4% real GDP growth (a full percentage point lower than the likely actual result), a 4.1% unemployment rate (probably a tenth too low), and 2.4% headline and core PCE inflation (most likely too low by four tenths for the core).  That economic outlook was tied to 75 basis points of rate cuts.  So, in 2024, the economy significantly outperformed the Fed’s expectations (again) and core inflation decelerated by markedly less than projected, but the FOMC cut by more than it had projected entering the year.  Interesting.

Let me try to tie all of this together with two assertions:

1. The FOMC is flying by the seat of its pants when it comes to setting policy.  There is no consistent translation from a given economic result to a policy path.  The Committee comes together every six to eight weeks and makes a judgment mostly by debating what feels right in the moment.  There is no effort by the FOMC to mark itself against monetary policy models that have performed well in the past (there are various versions of the Taylor Rule and plenty of other well-regarded models that would do the trick).  In fact, there is no systematic reaction function at all.  This is discretionary monetary policy setting at its most extreme.
2. In the short run, this Fed tends to overreact to fluctuations in the economic data.  There is a normal rhythm of ups and downs in the monthly economic numbers.  When one month is soft, more often than not, the next month compensates.  Or, at times, you might get 2 or 3 months in a row of strong or soft numbers.  But the underlying trend has been largely steady in recent years.  The Fed has more than once in the past two years gotten too optimistic after a string of high core inflation readings is followed by several softer ones.  Chairman Powell and others on the FOMC have tended to repeatedly write off the bad inflation readings and cherry pick the good ones.  In retrospect, as described above, Powell and others on the Committee also panicked at the end of the summer about the labor market when the unemployment rate ran up for four straight months and payroll growth slowed for a couple of readings only to find that the trend was largely steady all along.  Then, in December, the Committee concluded that, in fact, core inflation has not been decelerating by that much at all, so that the path to neutrality has to be dragged out over the next three years.

Hopefully, it is pretty obvious that this is a really bad combination.  Financial market participants are supposed to overreact and careen from one extreme to the other.  Fed officials are not.  The economic data alone did not drive the 200 basis point range in forward fed funds expectations last year that I discussed in my 2025 Outlook piece.  The Fed did that.

OK, with that as context, the big takeaway from the December FOMC minutes was that “a majority of participants noted that their judgments about this meeting’s appropriate policy action had been finely balanced.”  We know from the dots that there were four participants who wanted to keep rates on hold in December.  It sounds like quite a few of those in the majority who favored another cut had a pretty low degree of conviction.  I would imagine that, as in September, Chairman Powell insisted on the more dovish option – if there was any wavering over the course of the discussion.

In September, I suspect that Powell had to promise that there would be no more 50 BP cuts in the absence of an emergency to bring along a number of officials who were reluctant to support a 50 BP move at that time.  Similarly, I would imagine that the price that was paid to get to a 25 basis point cut in December was likely to promise to pause in January.  Hence, the follow-up that “participants indicated that the Committee was at or near the point at which it would be appropriate to slow the pace of policy easing.”  Every official who has spoken in recent weeks (since the meeting) has signaled that the Committee will probably take a pass in late January (the operative phrase seems to be “more cautious”).

On the economy, interestingly, the December FOMC minutes suggest that the bulk of the conversation tilted in a dovish direction.  The outperformance of economic growth was attributed solely to “favorable supply developments” and thus was not considered inflationary.  On inflation, as Powell laid out in his press conference, the view is that everything within core inflation is behaving in a manner consistent with the 2% target except for non-market-based services prices like housing and financial services, which can be safely dismissed:  “the increases were concentrated largely in non-market-based price categories and that price movements in such categories typically have not provided reliable signals about resource pressures or the future trajectory of inflation.”  Finally, the labor market was considered to be gradually easing and “broadly consistent with the Committee’s longer-run goal of maximum employment.”

None of that would seem to support the hawkish turn in policy guidance.  It feels like the FOMC has a very loose notion of neutrality.  In September, the funds rate was far too high and needed to come down fast.  By December, the Committee felt that it had gotten much closer to neutral and needed to be more careful about further cuts.  And yet estimates of neutral (the longer-run dots) only crept slightly higher from September.  Again, it is a very arbitrary way to set (or, more precisely, guide) monetary policy.  In my view, the FOMC was probably closer to the right answer in December than it was in September.  The median long-run dot at 3.00% is probably still somewhat too low, but I get the sense that there is a growing contingent on the Committee that is unwilling to rule out neutral being as high as 4%, which is closer to what all of this “more cautious” chatter suggests.

If this mindset persists, then the very small amount of easing priced in by the markets right now for 2025 would seem to be about right.  However, I am counting on at least one more overreaction from the FOMC in 2025.  I look for the economy to slow somewhat in the first half of this year and for the labor market to soften somewhat further.  If that is accompanied by two or three months’ worth of decent core inflation readings, I fully expect this FOMC to get back to where it was in September – super worried about the labor market and eager to cut by more than the financial markets currently project.  Would such a response be warranted?  Probably not.  But the question that financial market participants care most about is what the Fed will do, not what it should do.

On a separate topic, it is worth noting that there was no discussion at all about slowing or stopping balance sheet reduction.  The NY Fed Markets Desk reported that survey respondents have pushed back their median expectation for the end of balance sheet runoff to June 2025.  I think tapering starts in April but extends through the end of the year.  But 2025 could get messy, as debt ceiling dynamics will muddy the waters for at least the next several months and possibly for the majority of the year (this was also a complicating factor in 2019).