The Federal Open Market Committee (FOMC) of the Federal Reserve cut interest rates by 25 bps, with the Fed Funds target range now 3.5%-3.75%. This rate cut is not expected to significantly impact economic activity, which is currently expanding at a 2.5%-3.0% pace. There may be some positive effect on the still-weak housing market, via potentially lower mortgage rates. In his formal remarks preceding the Q&A of the press conference, Fed Chairman Powell cited downside risks to employment, attributing recent employment weakness to slowing labor force growth and noting “clearly softening demand.” The upside risks to inflation, which remains “elevated”, were also highlighted. For the first time since 2019, there were three dissenting votes: Stephen Miran voted for a more aggressive cut, while Austan Goolsbee (Chicago Fed) and Jeff Schmid (Kansas City Fed) voted against any cut.
Substantial attention was also directed to the implementation of monetary policy, a separate issue from the actual monetary policy itself. The key implementation topic was the announced increase in Fed purchases of short-term bonds, aimed at “improving the functioning” of the repo market and the money market sector. While this may look like a resumption of Quantitative Easing (QE), injecting money into the economy for the purpose of supporting economic growth, Chairman Powell (and the Federal Reserve) has been presenting this widely anticipated announcement as open market operations exclusively focused on ensuring adequate liquidity for the functioning of important sectors of the financial industry. Of course, these new actions have been given a name, though one not used by Chairman Powell in the press conference: “Reserve Management Purchases” or “RMP.”
This FOMC meeting also included the preparation and reporting of the Summary of Economic Projections (SEP). A quarter-point reduction in the target interest rate was widely expected, but there was significant uncertainty and interest in individual committee members’ views on current and future economic growth, unemployment, inflation, and interest rates. A notable number of committee members registered not only their dissent with today’s cut but also indicated considerable reluctance to support more than one rate cut in 2026. Chairman Powell himself emphasized the 75 bps in cuts that have been undertaken since September and placed the current level of the target interest rate as being “within a broad range of the neutral rate” of interest. For the first time in recent memory, Chairman Powell supported the notion that there are “plausible estimates of neutral [rates]”, as opposed to framing the neutral rate of interest as an unknown. Apparently feeling good enough about estimates of the neutral rate, Chairman Powell even stated that this rate cut places interest rates in the “higher range of neutral.”
The importance of the neutral rate of interest was explained in the context of managing the “tension” between the two goals of the Fed’s mandate (full employment and price stability), a tension which once again was described by Chairman Powell as “unusual” for his tenure at the Fed. If there is a relatively equal risk that employment will fall and inflation will rise, then monetary policy should be neutral. A change in the relative risks would presumably force a further change in monetary policy, but there is not enough information to allow for a more nuanced evaluation of these risks. “Neutral” in this context sounded as if it captured the amount of uncertainty within the FOMC over the path of economic activity, rather than representing any particular satisfaction about the economic outlook.
Tariffs were a somewhat surprising focal point of the press conference, apparently prompted by the looming Supreme Court decision on the validity of many of the tariffs introduced in 2025. Questions about tariffs gave Chairman Powell an opportunity to restate the view (“held by most of us”) that tariffs are a one-time price increase, not a driver of longer-term inflation. There was an interesting further elaboration that the committee believes that without the effect of tariffs, inflation would, in fact, be measuring quite close to the 2% inflation target of the Fed. Answering a cogent question about the direction of rates on 10-year Treasuries, which have risen 10 bps in recent weeks, Chairman Powell explicitly termed this an “inflation compensation” and made the observation that longer-term bonds seem to be consistent with the 2% inflation projection. Ten-year Treasury yields are arguably the most influential of market interest rates, impacting many business decisions and the pricing of consumer mortgages, so … ten-year Treasury markets see the need for compensation for inflation that the FOMC believes is transitory?
This press conference was especially remarkable for an extended discussion of productivity, with Chairman Powell boldly stating that “we are definitely seeing higher productivity.” One presumes he really meant “productivity growth”, since the growth in productivity— not “productivity” itself — is the key component to understanding longer-term trends in GDP. It is an arithmetic truism that total factor productivity growth plus labor force growth equals GDP growth. Chairman Powell declined to attribute the increase in productivity growth to AI alone, appropriately broadening the focus to include the likely increased use of technology and the development of new systems and processes, resulting from the business challenges of the pandemic years. Chairman Powell elaborated that he never expected to see five-plus years of 2% productivity growth and “this is clearly higher than that.” Although this merits some further examination of the time frame, it is true that for many years, economists have thought anything higher than 1.7% productivity growth difficult to obtain and even more difficult to measure. The importance of this discussion of productivity was not nailed down during the press conference, but it is worth understanding in terms of the Summary of Economic Projections, which, in general, described an FOMC that believes 2026 economic growth will be considerably higher and inflation slightly lower than they did in the September meeting. A forecast for increased productivity growth is a key element in making faster growth and lower inflation possible. Note: productivity growth is notoriously difficult to forecast.