By Chief Economist, Jeanette Garretty
The FOMC statement released today confirmed the intention to keep interest rates unchanged—and, somewhat surprisingly—provided subtle, important support for the current discussion in financial markets about interest rate cuts in 2024. “Cuts” in the plural; the Summary of Economic Projections (“SEP”) released in conjunction with the FOMC statement indicated at least one additional cut in interest rates beyond the one previously forecast for 2024, with a notable number of Fed members leaning towards a 100 bps reduction in interest rates in 2024. The consensus Fed forecast for the Fed Funds rate in 2024 now stands at 4.6%.
Accompanying this change in the rate outlook is a reduction in US economic growth to 1.4%, and a move downward in inflation, closer to 2% though not quite there yet (2.4%.) Not much discussed this morning is the fact that the SEP forecasts a 4.1% unemployment rate throughout 2024. This, should anyone be wondering, is what is called a soft landing. I am reminded of a Latin phrase: “Credo quia absurdum” (“I believe because it is absurd.”)
It is appropriate to remember that the (in)famous “dot-plots” which are the underpinning of the Fed’s economic and interest rate projections are NOT necessarily the result of economic modeling or the analysis of the Fed Research staff. The dot-plots are the forecasts of the individual Fed policymakers. Thus, it is important to look at the divergence of the dot-plots as well as the median, and the dot-plots in the just-released SEP are quite varied. A dissension in the outlook is not necessarily a bad thing, nor is it surprising in light of the recent deceleration in both inflation and growth; the dispersion of forecasts is, in many ways, consistent with policy being at a turning point. Nevertheless, the tighter consensus on the direction of interest rates and the economy that should form in the next few months may yet be less of the “almost everything the markets want” than implied by this SEP.
Chairman Powell’s opening remarks in the press conference emphasized both the success against inflation and the many uncertainties that still remain, specifically with respect to the continued deceleration in inflation. The first question sought to clarify the risk of an interest rate hike, and Powell clearly stated that the intention was simply to remind people that an interest rate increase is always possible, even if it is not currently probable.
A question about recession forecasts led to a rather predictable response by Chairman Powell that he doesn’t like to forecast. The Chairman claimed that he “has always felt” that the economy could cool without tipping into a recession, largely because of the “unusual economic circumstances” of the last two years. It is true that Chairman Powell always referenced in previous press conferences the possibility of a soft landing, but it would be a stretch to say that he seemed confident in that view. He now seems quite comfortable operating with a soft landing with no recession as a base case scenario.
As expected, many of the questions in the presser had to do with the SEP and what it really says (and how it is formed). Chairman Powell did not choose to elaborate on the above-mentioned difference of opinions but did feature the “bottoms-up” nature of the SEP forecasts.
There was a very cogent question about the influence of the Treasury markets in executing tightening or easing of monetary policy. In this case, Nick Timiraos from the Wall Street Journal highlighted the easing, that is already underway as a result of falling 10-yr. Treasury yields. Notably, Powell did not push back against Timiraos, emphasizing the market view that inflation is decelerating substantially, although Powell did use the question as an opportunity to emphasize that 2% inflation is not yet achieved and 2% inflation is still the target.
Regarding the state of the labor market, Chairman Powell focused on the development of a “better balance” in the employment data. The data he cited included labor force participation rates, the unemployment rate and its details, job quits and job openings. Wages are still a bit above what the Fed would think of as being consistent with 2% inflation, but Powell did not seem overly concerned, a view he first introduced after the November FOMC press conference.
Powell was asked what he would do if the economy slipped into a recession and inflation was still high or rising. His first response was a bit amusing: he had a hard time understanding the scenario described because he clearly thought it was a very unlikely combination of events. Once again, the abominable snowman myth of stagflation is returned to the mythology books. When specifically asked if he would contemplate cutting interest rates in a recession, he answered an unequivocal “yes” (at least I think he did—I’m not sure that’s what he intended.)
The subtext of the press conference was that the setting of monetary policy is going to be almost entirely driven by inflation and the achievement of the 2% target. If inflation continues to decelerate, rates might be cut sooner rather than later. Economic and monetary theory would normally present monetary conditions as needing to be appropriate for the economic conditions. If the US economy is growing at 1.4% and that level of economic growth is desirable, facilitating full employment, there would be no reason to stimulate the economy by easing monetary policy, i.e., cutting interest rates. Powell, who is no economist, did not choose to present the interest-rate-cut debate in this framework. The closest he eventually got, was in attempting a discussion of the neutral rate of interest, which he acknowledged may now be higher. One should be sympathetic; the neutral rate of interest, for all the many current discussions about it, is not directly measurable, making its use as a policy variable highly problematic. It would, however, sometimes be nice to have a higher proportion of theoretical economic content.
Chairman Powell made some comments near the end of the press conference that seemed to be a return to his much-maligned observations about inflation being “transitory” in light of the unusual circumstances surrounding the COVID pandemic. He said that current inflation was not caused by the usual “pot boiling over” price pressures but rather by a combination of supply chain disruptions and unusual rebounds in consumer spending. Perhaps the point is now that, in hindsight, the inflation was transitory, but “transitory” was a much longer period than anyone anticipated. Of course, he will never, ever use the word “transitory” again, nor will any economist. Yet, it very much seems appropriate to say that the COVID pandemic caused three years of economic disruption that is only now resolving itself.
The press conference concluded with a direct statement on Quantitative Tightening (QT) in response to a question asked almost as an afterthought. Powell quickly answered that there would be no change in the current direction of QT.
Make a note: On December 13 at 12 noon PT/3 pm ET, the Federal Reserve pivoted its monetary policy away from the extreme and rapid tightening that had begun in early 2022. This is now a new phase for monetary policymakers.
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