A cautious FOMC, but still likely to cut

Stephen Stanley | January 31, 2025

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The FOMC has followed through after signaling in December that it would downshift to a more cautious approach following 100 bp of rate cuts in the final three meetings of 2024.  The January 29 pause was universally anticipated, but opinions vary over what comes next. As for me, I’m sticking with my call that the FOMC will cut three times this year beginning in March.

Chair Powell and the committee strained to avoid sending too explicit of a signal about what comes next.  Powell repeated several times that the committee “does not need to be in a hurry” to adjust its policy stance.  He repeated that response when asked specifically about whether a March rate cut was still on the table.  As one of the few economists still calling for a March rate cut, I must admit that this answer was not terribly encouraging.  Nonetheless, Powell emphasized the Fed’s continuing data dependence, and I heard nothing to shake my confidence that the FOMC remains extremely responsive (if anything, too much so) to short-term fluctuations in the economic data.  The December data cycle has been generally robust (most notably, employment and retail sales but also new home sales and core capital goods orders and shipments among others), which made a noticeable difference in today’s discussion.  So, we are potentially just one weak monthly data cycle away from yet another shift in tone at the Fed.

While I’m sticking with my call for three cuts this year beginning in March, I want to see some of the early 2025 data before I seriously consider any changes to that forecast.  Based on what I heard today, at the margin, I am less confident about a rate cut in March, but I still see a very realistic path to three cuts this year, perhaps a little later than my current expectation.  I will keep you posted as my thinking evolves. But as noted above, I would like to see at a minimum some of the key January data before either reaffirming or tweaking my call.  In the next two and a half weeks, we will get January data on employment, retail sales, and consumer prices, all of which will be important.

FOMC statement focuses on current circumstances

The most recent FOMC statement included two changes from the December communique.  Both are related to the current economic situation and do not necessarily have important implications for the future direction of policy.  That said, they were both in the hawkish direction.

• Labor market upgrade. The description of the labor market went from “labor market conditions have generally eased, and the unemployment rate has moved up but remains low” to “The unemployment rate has stabilized at a low level in recent months.”  This tweak could be interpreted a few different ways.  The bottom line, that the unemployment rate is low, has not changed.  So, one could argue that this change merely reflects the passage of time since the labor market cooled last year.  Alternatively, I suspect that the prevailing interpretation will be that this change reflects a firming labor market situation, on the back of the solid December employment report.  The problem with this interpretation, of course, is that it is only valid until the next set of data.  One weak monthly employment report and we would probably be back to something close to the December language.
• Lack of inflation progress. In December, the statement noted that “Inflation has made progress toward the Committee’s 2 percent objective but remains somewhat elevated.”  The January communique states “Inflation remains somewhat elevated.”  The bad news is that we were no longer making progress, which reflects that year-over-year advances for both the headline and core PCE deflators are slightly higher over the past three months.  The good news is that the statement clearly does not say that inflation has accelerated.  The Committee presumably does not view inflation as meaningfully further from the 2% target than was the case late last year, merely that no incremental progress has been made recently.  Again, this assessment could change significantly (or not) with the next set of monthly numbers and thus does not necessarily say much about the policy outlook.

In his press conference, Chair Powell was asked about the language changes in the statement and downplayed them, characterizing them as language cleanup at the start of a new year.  He said that they were not meant to “send a signal.”

The January vote was unanimous.

Press conference headline: no hurry

Chair Powell spent much of today’s press conference stiff-arming questions about things that the Trump Administration may or may not be doing.  He deftly swatted away all of those questions, leaving less time to focus on the policy outlook—probably a plus for Powell, since he clearly wanted to avoid saying anything specific about where rates may be headed.

I learned a handful of things from Powell’s prepared statement and answers at the press conference:

• No hurry. As noted above, Powell several times emphasized that, having lowered rates by 100 bp late last year, the FOMC does “not need to be in a hurry” to adjust the policy stance.  He noted that the heightened uncertainty regarding policy should be passing and even mentioned that, to understand the economic impact of any tariffs, the Fed would need to see not only the specifics of the administration’s policies but also how our trading partners respond and how businesses choose to pass through the cost increases—or not.  At the margin, this all seems to argue for the Fed sitting on the sideline as long as the economic data allows.
• Meaningfully restrictive. Having said that, when asked, Powell volunteered that he still thinks policy is “meaningfully restrictive,” though less so than before last year’s cuts. He suggested that the FOMC would probably need to see further progress toward its 2% inflation target or softening in the labor market to justify additional cuts.  Still, his tone did not suggest that to me that he believes the Fed is done cutting rates, only that they are in no rush.
• No pressure. In his Davos appearance, President Trump said that he wants lower interest rates in the US and globally, sparkling concerns that he intends to pressure the Fed. When asked, Powell said that he had not been contacted by President Trump.  My sense is that Trump has far bigger fish to fry right now.  If he has any intention to pressure the Fed for lower rates, that has to be pretty far down his list of priorities at the moment.
• Progress toward 2%. The Fed’s story on inflation seems to shift quite often, usually to fit whatever narrative officials want to deploy. Powell repeated his view that the sources of high inflation are limited to housing, which decelerated noticeably in November and December, and nonmarket services prices, which he said do not correlate well to underlying inflation trends.  So, he remains generally optimistic that inflation will make “further progress” toward 2% even though it failed to do so in recent months.

Powell revealed that at the moment, the committee is very much focused on the year-over-year advances, because they get past the seasonality in the data.  As Dana Carvey’s Church Lady character might say “How convenient!”  In the first four months of 2024, the core PCE deflator rose by a cumulative 134 bp.  That means if we get gains of 0.3%, 0.2%, 0.2%, and 0.2% readings in the first four months of this year—not a particularly soft run of numbers presuming that widespread tariffs are not implemented right away—the year-over-year advance would slow by nearly half a percentage point, perhaps to 2.4%.  So, the Fed’s emphasis on the 12-month change comes at a very opportune time.  Note that Powell also stated, in response to a question, that the FOMC certainly does not need inflation to get all the way back to 2% to cut rates again.

This underscores my point that three rate cuts is still quite a plausible outcome for this year.  It is not unrealistic to think that we get to May and the year-over-year advance in the core PCE deflator has slowed by half a percentage point at the same time that payroll employment gains have slowed to close to 100,000 a month and the unemployment rate has risen by a tenth or two from its current level.  After how violently Powell and the committee swung to dovishness last summer, it is not hard to imagine the committee, which thinks that its policy rates are still “meaningfully restrictive,” cutting rates multiple times.

Abundant liquidity. Powell had nothing of substance to say about the balance sheet until asked directly near the end of the press conference.  When finally asked, he pulled out his prepared answer, which was that reserves are still “abundant,” about the same level as when balance sheet reduction started.  It seems clear that the FOMC is going to allow runoff to continue until it sees evidence in the behavior of money markets that liquidity is tightening.  In the complete absence of such evidence so far, the Fed is keeping balance sheet policy on cruise control.