MNI POLICY: Fed To Hold Door Open To Steady Rate Cut Path
MNI (WASHINGTON) - Federal Reserve officials this week will leave the door open to resuming interest rate cuts as soon as March but will also signal a higher bar for reductions amid signs that inflation could be stuck uncomfortably above its target.
While investors have sharply pared back expectations for Fed easing and do not see another rate cut until summer, the central bank won't close the door to rate cuts at any of its forthcoming meetings.
Rather than dwell on upside price risks, which include changes in trade and immigration policy from the new Trump administration, policymakers are inclined to express continued confidence that the disinflation process will persist.
Fed officials largely agree wage pressures are not a major contributor to inflation, and are not worried that strong labor market data could spark a new bout of inflation. They are also comforted by the expectation of decelerating shelter inflation and lower market-based measures of inflation. Most FOMC members also believe policy is still restrictive even in the face of strong economic growth.
Supporting a more sanguine view of inflation pressures, core CPI inflation slowed on a monthly basis to 0.2% in December after several months of 0.3% increases. Core PCE inflation is also expected to come in at 0.2% for the month, which would be the sixth reading at or below 0.2% in the last eight months.
Officials are focused on shorter-horizon measures in order to weed out potentially deceptive base effects in the annual data. But if core PCE inflation stays subdued, even the 12-month measure could be on track to fall to 2.2% by the March meeting.
HIGHER BAR
This does not mean policymakers are not attentive to lingering upside risks to inflation. This week’s decision will likely be accompanied by a clear message that more progress is needed before the Fed resumes cutting borrowing costs again.
Minutes from the December meeting showed participants said “the overall pace of disinflation had slowed over 2024 and that some recent monthly price readings had been higher than anticipated.” (See MNI INTERVIEW: Fed's Easing Bias No Longer Justified-George)
Consumers' one-year inflation expectations rose to 3.3% this month from 2.8% in December and are now above the 2.3%-3.0% range seen in the two years before the pandemic, according to the University of Michigan's Surveys of Consumers. Survey respondents cited worries over higher prices if President Donald Trump makes good on promises to impose tariffs on imports.
The FOMC is treading cautiously because it's uncertain how -- or when -- trade, immigration, tax cuts and deregulation will impact the economy and inflation.
DISAGREEMENT ON NEUTRAL
Even some of the more hawkish Fed officials are hopeful that disinflation will persist. But they believe the neutral rate of interest has risen enough that the Fed is already getting close to it. The top of the range of estimates of neutral is 3.9%, just half a percentage point below the current target range for the fed funds rate.
“I am fairly optimistic that inflation will continue to move in the right direction,” said Kansas City Fed President Jeffrey Schmid in a speech earlier this month. Even so, he argued “we are near the point where the economy needs neither restriction nor support and that policy should be neutral.”
The more dovish camp, in contrast, sees room for several more cuts because they do not believe the neutral rate has climbed all that much. The median FOMC estimate of neutral is nearly 150 bps lower.