February 1, 2025      

    The Federal Open Market Committee (FOMC) cut rates by 100 basis points between September and December 2024, but decided to pause rate cuts at its January meeting. Key reasons included “solid” growth in economic activity and an inflation rate that “remains somewhat elevated.” In his mandated bi-annual Monetary Policy Report to the Senate Banking Committee and House Financial Services Committee, Federal Reserve Chairman Jerome Powell reiterated that policymakers were in no hurry to cut rates further. This comes as there are questions about how restrictive monetary policy really is, how quickly policy changes may impact economic activity and the validity currently reported data in light of significant recent revisions to previously reported data. This high degree of uncertainty has the Fed in a wait-and-watch mode as the rapidly changing policies of the new Trump administration continue to unfold.

    The Trump administration’s initial and projected tariff policies may have been in evidence as imports surged in December as producers pulled purchases forward ahead of promised tariffs. The manufacturing sectors Purchasing Managers Index (PMI) from the Institute for Supply Management (ISM) saw the new orders component increase in November and December, but fall back in January. Some economists suspect it may have also been a factor in a larger-than-expected decline in January’s advance retail sales. Inclement wintry weather and the wildfires in California also likely played a role in the retreat.

     The Fed’s attempt to reset inflation back down to their 2.0% target has been challenging as progress stalled during the second half of 2024. January brought an upside surprise in the Consumer Price Index (CPI) and Producers Price Index (PPI). The CPI reading showed headline inflation rising at its fastest monthly pace (+0.5%) in nearly a year and a half, while the core (excluding food & energy) inflation’s gain (+0.4%) was the largest since March 2024. The headline and core Personal Consumption Expenditures (PCE) Deflator increases were more muted, but the Fed has to be concerned about inflation expectations becoming unanchored. The February University of Michigan Consumer Sentiment and Consumer Confidence Index report showed that consumers’ inflation expectations are trending in an unfavorable direction.

The January employment report, while noisy, still showed a solid labor market. The non-farm payroll report showed less net hiring than expected, but upward revisions to the prior two months lifted trend job growth. Benchmark revisions for all of 2024 were also not as negative as expected. Additionally, there were 573,000 employees not at work due to bad weather and wildfires in January. The unemployment rate declined for the second consecutive month to 4.0%, the lowest since May 2024. Questions on the future direction of the labor market abound, with uncertainty surrounding trends in immigration and the down-sizing the government.

     The Fed is stuck waiting for clarity on government policy and macroeconomic trends. The dilemma is that unpredictable economic effects have caused a downshift in consumer and business sentiment and raised downside risks to growth, while inflation concerns are percolating. As expressed in the minutes of the January FOMC meeting, the Fed has little appetite for cutting rates in the near term. With some uncertainty on how restrictive current policy rates are, the Fed believes it warrants a careful approach to rate policy adjustments. The majority of Fed members still seem to believe they will control inflation and the next move in rates will be down, but the timing and degree of further cuts is sufficiently uncertain that future events may alter that course.