Federal Reserve Chair Jerome Powell has signalled a pause in expectations for further easing, indicating that the US policy rate is now within a plausible range of neutral. At a recent press conference, Powell emphasised that the Fed is well-positioned regarding monetary policy, inflation, and the labour market, reflecting confidence in the current stance.

Powell acknowledged that upside risks to inflation remain but pointed out that service inflation continues to soften. He also highlighted that most of the recent increase in goods inflation stems entirely from tariffs. Without these tariff effects, inflation would be near the Fed’s 2% target. Tariffs appear to represent a one-time price level adjustment rather than an ongoing source of inflationary pressure. Taken together, these remarks suggest that, barring new tariff hikes, inflation should gradually return to target over time.

In terms of market expectations, the probability of a rate cut in April has risen from just over 50% to about 60%, while the chance of a cut in June is now around 87%.

Monetary Policy Stance and Rate Path

Powell stated that the policy rate is currently within a plausible neutral range. The Federal Open Market Committee (FOMC) is well-positioned to assess whether further adjustments are required, making decisions on a meeting-by-meeting basis without a preset path. He warned that “there is no risk-free policy path” and that when inflation and employment risks are balanced, policy should remain around neutral.

Committee members are divided: some favour holding rates steady, while others advocate for one or more cuts. Powell noted, “I could make the case for either side.” Although a rate cut is not the base case, opinions are evenly split. The decision at the latest meeting enjoyed broad support, but the effects of prior cuts are just beginning to take effect. No decisions have been made regarding January’s meeting. The Fed is front-loading Treasury purchases to smooth liquidity through the tax season.

Labour Market Conditions

While layoffs and hiring remain low, labour demand has softened. Data from September showed a slight rise in unemployment and a significant slowdown in job gains. The labour market is now less dynamic and somewhat weaker. Downside risks to employment have increased, with payrolls expected to decline by roughly 20,000 per month moving forward.

The cooling of the labour market is occurring more gradually than initially expected, partly due to a sharp drop in labour supply. Powell highlighted the need to monitor the risk of negative job creation closely but does not anticipate a sharp downturn in employment at current rates. He acknowledged the importance people place on the labour market and expressed a desire to avoid policy that curtails job creation. Regarding artificial intelligence’s impact on layoffs, Powell said it is too early to see effects in the data.

Inflation Dynamics

Inflation remains somewhat elevated, though there have been few inflation reports since the October meeting. Recent data showed a pickup in goods inflation while service sector inflation continued to moderate. Underlying inflation signals remain mixed, with near-term risks skewed to the upside due to goods prices.

Powell emphasised that goods inflation is now entirely driven by tariffs, with progress made this year in reducing non-tariff inflation. If tariffs were removed, inflation would fall into the low 2% range. While tariffs are viewed as a one-time price shock, there remains a risk this may not hold. Powell affirmed the Fed’s commitment to delivering 2% inflation over time.

Economic Activity and Growth

Consumer spending is solid, and business fixed investment continues to expand, supported notably by artificial intelligence-related expenditure. The negative effects from the recent government shutdown are expected to be offset by stronger growth in the following quarter. The baseline outlook anticipates solid economic growth next year.

Strong spending on AI data centres continues. Powell cautioned that government-shutdown-affected data, including CPI and household surveys, may be distorted, necessitating careful interpretation. He noted that a considerable amount of new data will become available before the January meeting.

Housing and Real Estate

The housing sector remains weak. Powell noted that a quarter-point rate cut is unlikely to substantially improve affordability. The core issue remains a long-standing shortage of housing supply, which the Fed’s monetary policy tools cannot address.

Risks and Uncertainty

Downside risks to employment have risen, and upside risks to inflation persist. Powell described the Fed’s dual mandate goals as “a bit in tension,” necessitating careful evaluation of incoming data. The household survey and CPI data could appear unusually high or distorted due to missing information from October and November. Policymaker projections carry a higher degree of uncertainty and are not a fixed plan.

Balance Sheet and Liquidity

The Fed judges that reserve balances have declined to ample levels. Treasury purchases are being front-loaded to manage liquidity through the tax season.

Internal Committee Dynamics

Despite differences of opinion, discussions within the FOMC are thoughtful and respectful. Members broadly agree that inflation remains too high and the labour market has softened. Differences centre on balancing the risks of inflation against those to employment. The latest policy decision received fairly broad support.

Productivity and AI

Powell highlighted signs of a positive productivity shock, with artificial intelligence expected to materially boost productivity in coming years. Greater productivity could support higher GDP growth while maintaining stable employment. If productivity averages around 2%, the economy can expand faster without overheating. This would suggest a higher neutral rate, though Powell cautioned “not all things are equal.”

Tariffs and Supply Dynamics

Goods inflation is fully attributable to tariffs rather than demand pressures. Removing tariffs would bring inflation down into the low 2% range. While tariffs are considered a one-time price shock, ongoing data will need to confirm this assessment.

Forward Look

Powell expressed his intention to leave the next Fed Chair an economy in good shape, characterised by a strong labour market and inflation under control. When asked about remaining on the Board after his term, Powell said he had no new information to share.

Original Source: Greg Michalowski of investinglive.com