The Fed: Stuck On Hold for Now

Federal Reserve Chair Jerome Powell’s comments after two days of policy meetings were not as hawkish as many had feared given that U.S. inflation and economic activity reaccelerated in the first quarter. While acknowledging that sticky inflation means interest rate cuts will come later than previously expected, Powell said officials had not seriously considered hikes. In our view, lack of progress on inflation in the first quarter could delay rate cuts until the end of the year or even into 2025.

Instead, officials seem attentive to downside risks, such as rising unemployment, and comfortable with pursuing something akin to the Fed’s opportunistic disinflation strategy of the 1990s. That could mean keeping rates on hold and allowing inflation to drift lower over time. In short, the Fed sees the costs of tightening outweighing the benefits of a more rapid decline in inflation.

Nevertheless, the May meeting of the Federal Open Market Committee (FOMC) was another reminder that the Fed’s reaction to macroeconomic regimes has shifted dramatically: The Fed is now willing to be patient with inflation back in “2-point-something” territory. Yet it also stands ready to cut rates were the economy to materially weaken and unemployment to rise.

Higher for longer

The Fed’s preferred inflation measure (core personal consumption expenditures (PCE) inflation) reaccelerated to 3.7% in the first quarter of 2024 compared with the same period a year ago, on an annualized and seasonally adjusted basis, following two consecutive quarters at target. We project this inflation gauge is likely to remain around 3% in the second quarter. However, the reacceleration did not prompt a more significant change in tone for Chair Powell. Speaking to reporters after the FOMC meeting, Powell emphasized that monetary policy remains restrictive; he noted the Fed could cut rates if downside risks to the labor market materialize; and he reiterated that factors such as residual seasonality, beginning-of-year effects, and statistical noise could make the current inflation resurgence temporary. A rate hike was still “very unlikely” at this point, he said.