Fed Holds Steady: No News Is Good News

In the aftermath of this week’s Federal Open Market Committee (FOMC) decision to hold the fed funds rate unchanged (which was what markets were expecting), markets and analysts concluded that Federal Reserve (Fed) members had changed their views on inflation and that they no longer expect the disinflationary process to continue. According to this interpretation, rates would either stay as they are today for longer or, need to be increased if, in fact, the disinflationary process stalls and/or if inflation starts to increase again.

However, we are not convinced that anything changed in the Fed members’ views since their December 2024 decision, as we argued in the write-up we sent after the Fed’s decision. Although there are plenty of risks that could keep the Fed from lowering the fed funds rate soon or even cause it to consider increasing it, Fed officials have no problem with the path of interest rates they set in December or with the disinflationary process according to our reading. We continue to believe that the Fed is still okay with lowering the federal funds rate twice during this year. Of course, as it likes to say, it will remain “data- dependent,” which means it will adjust the path if it is compelled to do so because of incoming data.

As we argued after the December 2024 decision, Fed officials “extended the runway” for achieving the 2.0% PCE price index target from 2026 to 2027, recognizing that the path toward the target may be delayed a bit more than they had expected. The reason for this extension could be related to potential changes in policies, i.e., tariffs, immigration, etc., or related to consumers and business inflationary expectations, or a combination of both of these factors. That is, all these new policies have the potential to keep inflation higher than expected and for a longer period. However, this is not a problem for the Fed, as the extension of the runway could be considered normal procedure when central banks use an inflation target to conduct monetary policy.

PCE Inflation

As an example, consider what happened after the 2008 Great Financial Crisis and before the pandemic, when, for more than a decade, the Fed struggled to bring inflation up to the 2.0% target for a sustainable period of time and had to introduce several new monetary policy instruments, i.e., Quantitative Easing (QE) and others, to fight global deflationary trends as shown in the graph below. These trends were so strong that the European Central Bank (ECB) not only implemented QE, but also tried a novel approach called “negative interest rates,” which had never been tried in the history of central banks and which the Fed has never implemented in the US.

PCE Price Index and Core PCE Price Index