By Chief Economist, Jeanette Garretty
May 2, 2024There is very little that was surprising in the May 1 interest rate announcement by the Federal Open Market Committee (FOMC). It was acknowledged by a number of Federal Reserve members weeks ago that progress toward the 2% inflation target slowed in the first quarter; the FOMC statement reiterated this observation. At the core, the issue was identified by the FOMC as nothing more than the absence of conclusive data that would allow for a cut in interest rates at this time (which probably also means June). Notably, there was no signal that an increase in interest rates was appropriate, nor that Federal Reserve monetary policy was not restrictive enough to eventually get to 2% inflation. In fact, the balance sheet run-off (“Quantitative Tightening”) was reduced slightly, perhaps to moderate some ongoing concerns over an overly restrictive monetary policy that would be inappropriate for the soft-landing of the economy in coming months (the stated reason was to provide liquidity and stability to money markets.) Absent from the FOMC statement was any tone of concern about the ability to achieve 2% inflation under current policy conditions, and there was an explicit citation of the “better balance” that has developed between the Federal Reserve’s dual mandates of price stability and full employment (a mandate sometimes shortened to “growth and inflation.”) One interpretation of all this is that the FOMC’s view on monetary policy and the economy is unchanged from the last meeting, while the timing for the first interest rate cut is still uncertain. The Fed Funds rate policy target was left unchanged at 5.25%-5.5%.
Chairman Powell opened the press conference by citing the GDP report for the first quarter of 2024, highlighting the domestic private purchases subcategory, which indicated economic growth of approximately 3%, not the top line number of 1.6% driven by inventory drawdowns and trade deficit figures. Clearly, the Fed is not worried about the strength of the economy (see the later comments about stagflation.) Chairman Powell couched the inflation and interest rate challenge as one of confidence, i.e., the first quarter inflation data did not give the Federal Reserve enough confidence to entertain a cut in interest rates now.
According to Chairman Powell, “evidence shows that policy is restrictive and is weighing on demand.” Specifically, job openings are coming down, quits, and hiring rates have normalized; in many ways, the job market is reacting to a “sufficiently restrictive” monetary policy. The service sector and the housing sector appear to be doing the same. The Fed will “retain its current restrictive stance” and be patient in giving economic sectors time to respond to the tightness of monetary policy.
In verbal bold type, Powell said it is “unlikely that the next policy rate move will be a hike.” This was a key statement and it was presented clearly and strongly. The Fed is decidedly convinced that the existing monetary policy is sufficiently restrictive. Interest rate cuts are (of course) going to be data-driven. Thus, it’s not appropriate to ease monetary policy yet. Interestingly — and importantly— Chairman Powell stressed that if the inflation data continued to disappoint, the Fed’s reaction would be to maintain rates at current levels, not raise rates.
Nick Timiraos from the Wall Street Journal asked a straight-up question about the strength in labor markets as a causal factor for inflation, providing Chairman Powell another opportunity to reiterate the Fed’s view that labor markets are not the key determinant of the difficulty in getting inflation to 2%. The Fed has been very consistent in this approach to employment strength. Furthermore, Chairman Powell sounded especially interested in throwing cold water on any thought that the Fed is targeting wages or wage growth; overall costs are appropriate to watch, and employment cost is a variable, but not the only variable. (Note: employment costs capture productivity improvements, falling when productivity increases, whereas wages/wage growth does not.)
Another key statement by Chairman Powell was that “the signal we are taking is that it is going to take longer for us to gain confidence that inflation is falling as desired, and we can make interest rate cuts.” Powell importantly said that his personal forecast is that progress towards 2% inflation is going to be made, and interest rates can be cut. The path he identified was one of either constant interest rates or falling interest rates, depending upon the confidence of the Fed in the forecast for the pace of falling inflation.
An appropriate question about possibly higher potential output for the US economy offered a moment of real economic debate. The essence of the question is that if potential output for the US economy is higher than currently thought, then it can grow faster without engendering upward pressure on price levels. Powell seemed to enjoy this discussion, even if the ultimate answer was that it is just hard to identify that potential output number and that inflation-fighting cannot be based on assumptions about potential output changing significantly.
An example of unreal economic debate was the question as to whether there is a time frame (number of months or years) over which persistent 3% inflation would occur and might trigger a rate hike. No, says Powell. A rather ridiculous question that seemed to reflect the fact that a number of these reporters badly wanted a storyline that would garner more headlines by trumpeting a potential rate hike. Chairman Powell was mostly successful in avoiding this headline trap, well aware that financial markets — especially bond markets— recently had started to hyperventilate about potential rate hikes. He probably didn’t want to go there because of real concerns about what that view might do adversely to an economic growth picture he largely likes.
One of the background mysteries in the monthly inflation data is why housing markets have not provided the inflation relief that was expected. Powell mentioned that the lags in the housing market are quite long and probably longer than anticipated. Rents take a while to adjust, but it does appear that market rent growth is low and likely to stay low. The Fed expects that disinflation in the housing market will eventually show up in the measured inflation numbers.
Can disinflation still happen without economic pain? It used to be a Federal Reserve view (2021) that economic pain was required. When asked about this, Chairman Powell comfortably accepted that this pain did not happen and that this was wonderful. He side-stepped the issue of what future economic pain might be tolerable and what might not while seeming to say that unemployment rates a few tenths of a percentage point above where we are now is not intolerable.
Stagflation has suddenly emerged as a topic again, both in pre-press conference commentary by various financial news pundits and in the press conference itself. Great line by Powell: “I don’t see the ’stag’ or the ‘flation’.” There is simply no way to discuss stagflation when employment growth is strong, economic growth is in the 2.5%-3% range, and inflation is not high, even if it is not as low as the Fed wants. Later, he did say that an “unexpected weakening” in the economy would catch the Fed’s attention, but he clearly didn’t see that weakening on the near horizon.
Key Powell words at this press conference: restrictive monetary policy, confidence, time, patience. These words sum it all up pretty nicely.
And the final word award goes to: ” We have many people (on the Board) who are not Ph.D. economists,” thereby improving the Federal Reserve’s diversity of thought. Chairman Powell is a lawyer. Does this mean the addition of lawyers to a group of Ph.D. economists beneficially improves the diversity of thought? Placing emphasis on the benefit of diversity on the Federal Reserve Board . . . I’d like an economic study on that!!
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