January 2025 FOMC Meeting Postmortem

The Fed did not change its policy rate, and signals from their statement and Chair Powell's remarks suggests they'll be likely on hold until close to mid-2025.

As expected, the Fed kept its policy rates on hold. Based on the post-meeting statement and press conference, data trends and policy uncertainties coming from the new administration the Fed will be in no hurry to change its policy rate anytime soon.

Key takeaways:

• The FOMC kept the Fed funds target range unchanged at 4.25%-4.50%. There was no change in the pace of reductions of the Fed’s holdings of Treasury and mortgage-backed securities

• The statement following the rate decision changed only modestly with it signaling refocus to the inflation side of the Fed’s dual mandate away from the employment side by emphasizing stability in the labor market and dropping “progress on inflation” from the statement.

• At the post-meeting press conference Chair Powell repeated his previous view that current policy rates are ‘meaningfully, but not highly, restrictive ‘. He emphasized that a Fed commitment to achieve its inflation goal sustainably and that the framework review will not impact on the inflation target. The Fed is no hurry to make any further rate changes. Lastly, it’s clear the Fed is highly uncertain about the impact of tariff hikes in the current environment and would not necessarily ‘look through it’ as it did back in 2017-2019.

• The Fed will likely remain on hold to at least the May FOMC meeting. However, keep an eye on inflation expectations amongst firms and households: if these continue to drift upwards in response to D.C. policy initiatives, expect a hawkish policy shift sooner rather than later.

Decision, Post-Meeting Statement and Post-Meeting Press Conference

As expected, the FOMC decided to keep the Fed funds rate target range unchanged at 4.25%-4.50%. As foreshadowed in my preview for today’s meeting, changes to the post-meeting statement were minimal:

Recent indicators suggest that economic activity has continued to expand at a solid pace. Since earlier in the year, labor market conditions have generally eased, and the unemployment rate has moved up but remains low. The unemployment rate has stabilized at a low level in recent months, and labor market conditions remain solid. Inflation has made progress toward the Committee's 2 percent objective but remains somewhat elevated.

The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. The Committee judges that the risks to achieving its employment and inflation goals are roughly in balance. The economic outlook is uncertain, and the Committee is attentive to the risks to both sides of its dual mandate.

In support of its goals, the Committee decided to lower maintain the target range for the federal funds rate by 1/4 percentage point at 4-1/4 to 4-1/2 percent. In considering the extent and timing of additional adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks. The Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities. The Committee is strongly committed to supporting maximum employment and returning inflation to its 2 percent objective.

In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook. The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee's goals. The Committee's assessments will take into account a wide range of information, including readings on labor market conditions, inflation pressures and inflation expectations, and financial and international developments.

Voting for the monetary policy action were Jerome H. Powell, Chair; John C. Williams, Vice Chair; Thomas I. Barkin; Michael S. Barr; Michelle W. Bowman; Raphael W. Bostic; Susan M. Collins; Lisa D. Cook; Austan D. Goolsbee; Philip N. Jefferson; Adriana D. Kugler; Alberto G. Musalem; Jeffrey R. Schmid; and Christopher J. Waller. Voting against the action was Beth M. Hammack, who preferred to maintain the target range for the federal funds rate at 4-1/2 to 4-3/4 percent.

FOMC Statement, December 18, 2024 (with annotations relative to the January 29, 2025, FOMC statement).

As becomes apparent from the annotated statement above, the few changes to the statement reinforced the Fed’s shift since the December meeting away from the employment side of its dual mandate in favor of the inflation side and now more clearly acknowledging disinflation progress stalled.

Not surprisingly, Chair Powell fielded a lot of questions with regards to potential policy initiatives from the new administration in Washington D.C. Equally unsurprising, the Fed chair did not really comment on any of those potential new policies. Nonetheless, there were some interesting takeaways from the press conference. While Chair Powell downplayed the importance of the dropping ‘progress on inflation’ from the statement, it was just an exercise in “cleaning up the language” (Powell), he did very clearly emphasized several times the Fed’s “[..] commitment to achieving its inflation goal sustainably” (Powell) when discussing challenges to the inflation outlook and also the “[…] framework review would under no circumstance change the Fed’s inflation goal” (Powell). The latter I took as a preemptive signal that the Fed will resist any pressure from the administration to water down the current 2% inflation target. So, while recent inflation data might have been positive, the Fed will be more prepared than before to react to any disappointing inflation releases. Part of it seems reflective of its eagerness to protect its independence.

In relation to the labor market, Chair Powell followed the statement in emphasizing that the labor market is in “[…] a good place” (Powell). In terms of risks, Chair Powell did note current historically low hiring rates and a key metric to keep an eye would be the layoff rate, as a rise in layoffs could start off a rapid rise in the unemployment rate given those low hiring rates. On the other hand, Chair Powell referred to subdued population growth as a force that could keep a lid on any rise in the unemployment rate: slower population growth owing to less net immigration would lower the breakeven pace of jobs growth (i.e., the pace that keeps the unemployment rate unchanged). This is a clear sign that Fed policy makers have already incorporated the impact of less immigration and the impact on labor supply growth in their outlooks. This is not surprising as the immigration channel for higher labor supply already was shut off during the final year of the Biden administration.

Finally, the Fed is really uncertain with regards of the impact of tariff hikes on the economy under the current environment. When asked about this Chair Powell did notice that compared to 2017-2019, we’re in different circumstances as “[…] we just went through a high inflation period“ (Powell). This, at least implicitly, seems to (rightly IMO) recognize that inflation perceptions now are different than back then, which could alter the response to tariff hikes. But Chair Powell also “[…] did not know” (Powell) how new tariff hikes would impact the economy. It appears the Fed will employ a ‘wait-and-see approach’ and alter its rate policy ex-post and not ahead of when tariff hikes are being implemented.

Beyond Today’s Meeting

With average nominal short-term interest rate pricing in January only marginally lower than in December and “Main Street” near-term inflation expectations shifting up from around 2.5% to about 2.7%, the perceived policy stance of the Fed for the year ahead has eased to close to neutral as opposed to the Fed’s own view of a restrictive stance in the December SEP (chart above). In my January FOMC preview I noted that such an easing in expected stance due to rising inflation expectations should be a worry for Fed officials that are confronted with sticky inflation and increased policy uncertainty.

Inflation might well be in a good place to return back to a sustained disinflation path back to 2% owing to housing services inflation, with Chair Powell singling this out as a hopeful factor driving such a dynamic. Of course, housing services inflation is less impactful for core PCE inflation than for core CPI inflation (a weight of less than 20% in core PCE vs. a 40% weight in core CPI). Also, the year/year core PCE inflation readings will rapidly become favorable for the first quarter of this year if a start-of-the-year reacceleration in monthly inflation rates does not occur (chart above), and this might give the Fed some reprieve for its rate setting policy near term.

But even when a start-of-the-year reacceleration does not happen, if not careful the Q1 base effects might well distort the inflation outlook. Incorporating the consensus forecast of 0.18% month/month core PCE inflation for December, the average month/month core PCE inflation rate for 2024 was about 0.23%. If we would have that again this year, the year/year core PCE inflation path would likely just be in line with the Fed’s own 2025 core PCE inflation forecast (i.e., at the upper bound of the central tendency) as per the December SEP (red compounded line in the above chart). Really what the chart above makes clear is that average monthly core PCE inflation for 2025 should be at most 0.23%, and certainly less, in order to have two or more rate cuts this year (absent a recession, of course). This might well be ambitious given the potential impacts of a slower labor supply growth and impending tariff hikes.

The chart above also makes clear that if the earlier mentioned base effects occur, we’re not able to discern between the different possible year/year paces for core PCE until we have the April PCE data in hand. By then, a path consistent with an on average less than 0.25% month/month inflation rate should result in a year/year core PCE inflation rate of 2.4% or less in April; a higher pace than that would be an adverse signal for the Fed.

From today’s rate decision it seems that, for now, the Fed is prepared to sit tight and wait for that April PCE data, which they’ll have by the time of their May FOMC meeting. It’s a risky approach though IMO, as inflation expectations already started to shift in response to increased policy uncertainty, which if it endures could compel the Fed to have to make a hawkish move to address this dynamic.

Based on today’s signaling, data trends and policy uncertainties it is safe to say that the Fed will remain on hold to at least the May FOMC meeting. However, keep an eye on inflation expectations amongst firms and households: if these continue to drift upwards in response to D.C. policy initiatives, expect a hawkish policy shift sooner rather than later.