The Federal Reserve Open Market Committee (FOMC) left its target interest rate range unchanged at 3.5% to 3.75%. The most significant reason behind this decision appeared to be the current strength of the US economy, described in the opening paragraph of the FOMC statement as “economic activity expanding at a solid pace. While inflation was referenced, it was not cited as being well-above the Federal Reserve’s policy target of 2%, as has sometimes been the case. “Inflation remains somewhat elevated” was a very modest statement, as these things go. The biggest news in the announcement was that this time, there were two dissenting votes, both arguing for a quarter-point rate cut: Stephen Miran and Christopher Waller. Miran was expected to dissent, and perhaps Waller should have been expected as well, given that he is the only Federal Reserve Board member currently in the running to succeed Powell as Chairman.
Chairman Powell’s press conference was probably something that only an economist could love. Questions about Lisa Cook, criminal investigations, Mark Carney’s speech at Davos (!), and even the Fed Chairman’s own statement on January 11 regarding the various maneuvers of the Executive Office received a terse but somewhat amused “I can’t comment about that”, eliciting no small amount of laughter from the press corps. On the other hand, questions about the process for determining the impact of tariffs, the long-run trajectory of the budget deficit, and the “stabilization” of labor markets received detailed and animated answers. Without going into the technical aspects of those answers – other than to mention Chairman Powell’s quite fascinating discussion of how the Fed staff has been tracking tariff impacts at a very microeconomic level, starting with an announcement by the President and continuing through the supply chain until final purchaser prices are established – the conclusions of Chairman Powell’s (and the FOMC) analyses were notable:
- There has been a “clear improvement” in the outlook for economic growth. The strength of consumer spending and the overall economy has been “surprising” and impressive, serving to reduce the upside risks on inflation and, especially, the downside risks on employment that were in focus at the previous FOMC meeting. The risks still exist, and there is still a great deal of economic uncertainty, but the FOMC is much more comfortable with its understanding of both the impact of tariffs and the state of the labor market.
- Tariff effects have moved through the economy in ways that are understandable, and a lot of the effects, to date, have happened. Price increases have overshot the Fed’s 2% target primarily in the goods sector that was most impacted by tariffs, while disinflation has been witnessed in the services sector. Tariff-related inflation has occurred very much as the Federal Reserve expected, with three sources of error: 1) tariffs that were implemented at a lower level than what was originally announced, 2) lack of retaliatory tariffs from US trading partners and 3) the fact that the pass-through of tariffs to consumers was moderated by a large number of suppliers bearing some of the tariff burden. This latter point remains a cause for vigilance, however, as Chairman Powell alluded to conversations indicating that businesses may not continue to bear that tariff burden in 2026.
- Labor market conditions “may be stabilizing”, with a “good part” of the slowing of employment that concerned the FOMC at earlier meetings now attributable to the slowing of labor force supply. The quality of labor market data may have improved due to the resolution of the government shutdown (note: the quality of labor market data collection and the tendency to significant downward revisions which Chairman Powell mentioned after the last rate cut was NOT addressed) and with the outlook for economic activity “substantially improved,” US labor markets appear to the Fed to be in better balance. “There is some tension between inflation and employment, but much less than at the last meeting.” Chairman Powell did acknowledge that the current labor market situation is difficult to read and offered a rhetorical question that should not be overlooked: “If demand and supply [for labor] are in equal balance but there are no jobs being created, is that desirable?” It was clear that everyone – the Fed, the press, investors—would be thinking about the impact of AI on these questions of balance, but Chairman Powell said that the Fed cannot yet see clear signals in the macroeconomic data, adding that “we don’t have the tools to address” the microeconomic impact of AI, [we only have the tools to address] “the macroeconomic implications.”
- Fiscal policy is front-and-center this year. While monetary policy can do some things, many of the items that concern people and many of the questions from the press beg for fiscal policy solutions. Chief among these concerns would be affordability, job availability (per the negative responses in this week’s Conference Board consumer survey), and the so-called K-shaped economy. Another fiscal policy item of interest would be the “fiscal trajectory”, on which Chairman Powell chose to make more comments than some might have otherwise expected. Chairman Powell made a clear distinction between the current federal government deficit (“not a problem at all”) and the path of future deficits (which is ‘unsustainable” and must be dealt with). It was subtle, but probably intended, that Chairman Powell would choose to shift the gaze a bit to fiscal policy responsibilities for economic outcomes.
- Target interest rates are “in a range of plausible estimates of neutral.” This represented a decided shift in tone and implied that the entire FOMC (minus Miran and Waller?) had discussed the issue of a neutral monetary policy stance and had solidified around a view that was quite a bit more confident than the tenuous commentary following the last FOMC meeting implied. Upon questioning, Chairman Powell acknowledged that the current target interest rate was probably at the upper end of neutral, but continued to signal a high comfort level with the current positioning of policy. Not only was the strength of economic activity repeatedly cited as support for the neutrality of current policy, but also the sharp reversion of inflation expectations back to what they were (lower) before tariffs were announced. When asked by a reporter how cutting rates further would not be anything other than inflationary, given the current pace of economic growth, Chairman Powell correctly referenced the difference between output and the economic concept of “potential output”; if productivity growth raises potential output, then a rate cut is not necessarily inflationary even in a period of rapid growth and balanced labor markets.
It has been mentioned many times that Jerome Powell is not an economist; he is a lawyer. Nevertheless, in sharp contrast with far too many previous press conferences, his answers to the questions in this press conference were a confident and largely theoretically-correct presentation of the economic complexities that the Federal Open Market Committee will face throughout the year, irrespective of the imminent change in the chairmanship.