Vital Statistics:
Stocks are lower this morning after markets digest the Fed move yesterday. Bonds and MBS are up.
As expected, the Fed didn’t make any changes to the Fed Funds rate, and the dot plot became marginally more hawkish. You can see the comparison between December (left) and March (right) below. The central tendency is for 50 basis points of cuts this year.
The forecast for 2025 economic growth was revised downward from 2.1% to 1.7%, while the unemployment rate was bumped up to 4.4% from 4.3%. The estimate for headline PCE inflation increased from 2.5% to 2.7%, while the estimate for core PCE inflation rose from 2.5% to 2.8%.
Despite the hawkish plot and forecast, bonds rallied because the Fed is reducing quantitative tightening, and will cap runoff at $5 billion per month instead of $25 billion per month. This will create incremental demand for Treasuries at bond auctions, which will help absorb supply. The Fed did not adjust its runoff for MBS.
The press conference prepared remarks are here. The highlights are below:
Economic activity continued to expand at a solid pace in the fourth quarter of last year, with GDP rising at 2.3 percent. Recent indications, however, point to a moderation in consumer spending following the rapid growth seen over the second half of 2024. Surveys of households and businesses point to heightened uncertainty about the economic outlook. It remains to be seen how these developments might affect future spending and investment.
In the labor market, conditions remain solid. Payroll job gains averaged 200 thousand per month over the past three months. The unemployment rate, at 4.1 percent, remains low and has held in a narrow range for the past year. The jobs-to-workers gap has held steady for several months. Wages are growing faster than inflation, and at a more sustainable pace than earlier in the pandemic recovery. Overall, a wide set of indicators suggests that conditions in the labor market are broadly in balance. The labor market is not a source of significant inflationary pressures
Inflation has eased significantly over the past two years but remains somewhat elevated relative to our 2 percent longer-run goal. Estimates based on the Consumer Price Index and other data indicate that total PCE prices rose 2.5 percent over the 12 months ending in February and that, excluding the volatile food and energy categories, core PCE prices rose 2.8 percent. Some near-term measures of inflation expectations have recently moved up. We see this in both market- and survey-based measures, and survey respondents, both consumers and businesses, are mentioning tariffs as a driving factor. Beyond the next year or so, however, most measures of longer-term expectations remain consistent with our 2 percent inflation goal.
Looking ahead, the new Administration is in the process of implementing significant policy changes in four distinct areas: trade, immigration, fiscal policy, and regulation. It is the net effect of these policy changes that will matter for the economy and for the path of monetary policy. While there have been recent developments in some of these areas, especially trade policy, uncertainty around the changes and their effects on the economic outlook is high. We do not need to be in a hurry to adjust our policy stance, and we are well positioned to wait for greater clarity.
Finally, the Fed Funds futures now see a 70% chance for a rate cut at the June meeting, and have 3 cuts this year as the most likely scenario. We will probably see 25 at the June, September and December meetings.
If we take the 4 issues Powell mentioned: trade, immigration, fiscal policy and regulation, we can talk about how it affects growth and inflation.
Trade: tariffs will be a net negative for growth and inflation, at least in the short term. Trump is hoping that tariffs will either (a) force our trading partners to reduce their tariffs or (b) increase investment in domestic production. If (a) happens, that is a positive for growth and inflation. If (b) happens, that is probably good for growth, but not so much for inflation. If a trade war is the result, it will be bad for growth and inflation.
Immigration: Reducing immigration will probably be bad for inflation and growth in the short term. That said, it probably won’t have a big impact either way.
Fiscal Policy: Reducing government spending will reduce GDP and inflation. As government workers are cut, and contracts decrease, the labor market will weaken.
Regulation: Deregulation generally reduces costs, so it will be positive for inflation and growth.
I suspect the net effect of all of this will be minimal, but the possibility for outsized effects remain a tail risk. So chances are it won’t affect monetary policy one way or the other. Notwithstanding the jump in inflationary expectations out of the UMich consumer sentiment survey, pricing on 5 year TIPS remains more or less in the same range it has been in for the past 2 years. The pricing on 10 year TIPS is even less dramatic.
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