Stephen Miller
As was pretty much universally expected the Fed’s Federal Open Market Committee (FOMC) kept the policy rate target range unchanged at 4.25-4.50 per cent when it met overnight.
The Fed had clearly signalled a degree of circumspection regarding the pace of easing through 2025.
The current (December minted) “dot plot” wound back the median expectation for policy rate cuts for 2025 from 100 basis points (bps) to just 50bps. That implies just two 25bp cuts over the eight scheduled Fed FOMC meetings this year.
The Fed Statement noted “that economic activity has continued to expand at a solid pace” while the “unemployment rate has stabilised at a low level” rather than referencing an “easing in labour market conditions” as it did in December. Importantly, the Statement removed a December reference to “progress” on inflation noting instead that “[i]nflation remains somewhat elevated”.
The Statements appeared to put a ‘hawkish’ overlay on the decision to leave the policy rate unchanged even if, in my opinion, the Statement remains consistent with that “dot plot” issued in December.
Indeed, Fed Chair, Powell, is in his press conference seemed to provide a more moderate hue saying that the Fed “expects to see further progress on inflation” but is not “running a preset course” and “does not need to be in a hurry” to adjust the policy rate. He downplayed the tweaking of the FOMC Statement as “cleaning up the language”.
Indeed, markets seemed more settled once the moderate tone of Powell’s press conference became apparent.
Nevertheless, some market participants are pondering whether the Fed is now in an indefinite pause: an extended sabbatical rather than a short break. Some even speculate that the next move might be an increase in the policy rate (unlikely in my view).
Certainly, progress on inflation looked to have stalled in the latter part of 2024 and despite a marginally better than feared result for December, CPI inflation is proving “sticky”.
Meanwhile, the labour market has shown surprising resilience reflecting stronger than expected economic activity growth.
Recent CPI developments are a reminder that the process of disinflation tends to be disjointed: a process of “two steps forward and one step back” with the “last mile” to the inflation target proving particularly challenging, particularly in an environment (such as in the US) where economic activity is resilient.
That is only given emphasis by the incoming Trump Administration’s economic policy agenda which includes large tax cuts and tariff increases which are likely to exacerbate inflationary trends. As are proposals to curtail immigration.
Yesterday’s FOMC announcement and Powell’s press conference suggest that financial markets will prove challenging for investors: inflation is “sticky”; the Fed is emphasising that the future is a little opaque; a mercurial President is threatening to implement a controversial (and probably inflationary) agenda; and risk markets are priced for benign outcomes reflecting the positive tailwinds of deregulatory action and tax cuts.
Inflation and its direction is a key uncertainty as is the related question of the direction of bond yields, particularly given the gargantuan budget deficit.
Markets have priced just short of two rate reductions this year – not that different from the “dot plot”.
If there is progress on inflation, as it seems Chair Powell continues to expect (tariffs etc. notwithstanding) that “dot plot” remains the most appropriate reflection of likely Fed movements even if there is a wide band of uncertainty around the implied central outcomes of the “dot plot”.
In that context my best guess is that the short break remains the appropriate metaphor for the Fed rather than an extended sabbatical.
Bank of Canada: flying blind
As had largely been anticipated the Bank of Canada overnight cut its policy rate by 25 basis points (bps) to take the policy rate to 3.0 per cent.
That move was the sixth successive policy rate reduction taking the policy rate from its peak of 5.0 per cent to its current 3.0 per cent.
More significantly the Bank suspended guidance with Governor Tiff Macklem referencing “a lot of uncertainties”, particularly with regard to US tariffs, and adding that in such an environment it “didn’t seem very useful to provide guidance.”
Inflation looks to be comfortably within the target range with headline inflation at 1.8 per cent and trimmed-mean inflation at 2.5 per cent. Economic activity growth and the labour market are, however, languishing.
In that context the suspension of guidance is an attempt to retain maximum optionality but wouldn’t preclude further cuts should US tariffs curtail activity growth.
What is a more interesting conjecture is what any retaliation from Canada might mean for inflation and whether that might forestall any cuts.
