On Wed, the US Federal Reserve hit pause on rate cuts for the first time since the current rate-cutting cycle began in Sep 2024. The federal-funds target range will remain at 4.25-4.50%. Chair Jerome Powell referenced 2.8% (est.) growth in core PCE (Personal Consumption Expenditures) excluding volatile food and energy prices – which is the Fed’s preferred price index – over the 12 months ending Dec 2024. (Total PCE rose an estimated 2.6%, while CPI rose 2.9% during the same period.) As Powell noted, this “remains somewhat elevated relative to our 2% longer-run [inflation] goal.” Core PCE has also generally been meandering in the wrong direction since Jun 2024. Powell went on to say, “[W]e do not need to be in a hurry to adjust our policy stance,” signaling he doesn’t intend to do a quick reversion back to cuts.

In his press briefing, Powell was clear that the 2% inflation goal would be retained during his tenure. In response to questions, he elaborated, “I think that goal has served us well over a long period of time. It is also the sort of global standard [among central banks].” He also emphasized that a review of the 2% target – which was not being considered anyway – would be particularly inappropriate during a period when the goal was not being met.

The Fed’s decision to pause rate cuts wasn’t a surprise to the markets, which was assessing that outcome at a 97% probability the day before. Still, it hasn’t been a smooth descent for the Fed, which started the rate-cutting cycle in Sep 2024 with a surprise 50 basis-point cut, despite inflation still hovering around 2.6%. The following two cuts were a more moderate 25 points each, and now there is this current pause. It is particularly awkward because the Fed was late to respond to rising inflation – ignoring signals going as far back as Dec 2020 and maintaining its view that the inflation was “transitory” until 2022.

Certainly, it puts the Fed and Powell in the line of fire of the newly inaugurated US President Donald Trump. Two hours after the Fed’s decision, Trump posted a scathing critique on Truth Social. He said that “Jay Powell and the Fed failed to stop the problem they created with Inflation” and that “[t]he Fed has done a terrible job on Bank Regulation,” attributing the failures to an over-focus on DEI, gender ideology, green energy, and climate change.

Trump has a history of challenging Fed independence. While Powell has indicated that he has had “no contact” with Trump, Trump just last week told leaders at the World Economic Forum in Davos that he would “demand that interest rates drop immediately.” During the campaign, Trump said, “I don’t think I should be allowed to order it, but I think I have the right to put in comments as to whether the interest rates should go up or down.”

With respect to Trump’s critique of the Fed’s focus on DEI, it’s unclear whether Trump’s recent executive order for agencies to end DEI is applicable to the Fed as an independent agency. The Fed under Powell generally seeks to align with the “spirit” of such executive orders, but, in this case, it is governed by the Dodd-Frank Act, which requires the Fed to maintain Offices focused on inclusion. (Trump’s executive order is to be “implemented consistent with applicable law.”)

Fed chair Jay Powell has been clear that he would not step down if Trump asked him to resign, but his term as chair runs out in May 2026 in any case. (Trump said previously during the campaign that he would not reappoint Powell.) Trump will likely have the opportunity during his term to appoint both a new Fed chair as well as another Board governor (i.e. 2 of the 7 in total, each of whom serve 14-year terms). The 12 voting members of the rate-setting Federal Open Market Committee, or FOMC, are the 7 Board governors, the New York Fed president, and 4 of the other 11 regional Reserve Bank presidents on a rotating basis. Powell’s term as a member of the Board runs until Jan 2028, although Fed chairs usually resign from the Board after their term as chair ends. Based on his appointments thus far, Trump is likely to appoint loyalists.

The Fed’s wait-and-see posture is, in part, due to “policy uncertainty” stemming from the new administration still being in its early days. Trump has been very active in implementing his campaign promises through a spate of executive actions and orders – a total of 73 actions including 42 executive orders as of this writing. While the labor market and unemployment rate (4.1% as of Dec 2024) have largely stabilized over the past year, inflationary pressures can come from new policies – such as the promised 10-20% tariff on all goods and 60%+ tariff on Chinese goods, import/export controls (incl. closing the de minimis loophole), US pullout from trade agreements, tightened immigration and mass deportations, energy policy, fiscal policy, and regulations and deregulation. Powell also views the economy as strong and the current Fed target range as meaningfully restrictive already. And, as Powell put it, “when the path is uncertain, you go a little bit slower."

As of this writing, the interest-rate futures market is expecting a long pause, with the next cut being 25 basis points in Jun 2025. Based on futures, there may be a 50-basis-point descent in total for the year by Dec 2025. The range centers around 25 to 75 basis points; most banks concur with two rate cuts, although projections range from zero rate cuts to as many as 5. Keep in mind the futures market is frequently wrong (as our team at 6Pages has experienced time and again). Powell has signaled that all options are on the table – including rate hikes – and that the Fed will be looking for “real progress on inflation or alternatively some weakness in the labor market” (the Fed’s dual mandates).

The Fed will continue to reduce its securities holdings. The Fed, after Covid-related operations ballooned its balance sheet from $3.9T in 2019 to a $9T peak in 2022, ended its asset purchases in Mar 2022 and began reducing its asset portfolio in Jun 2022. This week, the Fed confirmed it will continue shrinking its current $6.8T balance sheet and tightening credit by allowing up to $60B in securities – $25B in Treasuries and $35B in mortgage-backed securities (MBS) – to mature each month without replacement (a more conservative approach than outright sale). While, at this rate, it would take 4 years for the balance sheet to return to 2019-era size, that’s not what the Fed is aiming for. It is steering towards “ample reserves” – which help it influence rates and administer policy – based on signals such as the time of day when large banks are sending payments to dealers. Powell recently said indicators suggest that reserves are still abundant.

The other piece of the pie here is productivity. The US has been seeing a productivity boom since mid-2023. Since then, year-over-year productivity growth has ticked up from 0% (Q1 2023) to 1.7% (Q2 2023) to 2.7% (Q3 2023), 2.7% (Q4 2023), 2.8% (Q1 2024), 2.4% (Q2 2024), and 2.0% (Q3 2024). As points of reference, the average year-over-year productivity growth since tracking started in 1948 is 2.1% and the average over the past decade is 1.7%. From a macroeconomic perspective, productivity growth is one of the best pieces of news a country can get. It can mean higher wages without higher prices (assuming productivity outpaces wages), which would have a deflationary effect. It all depends on whether the boom will continue – or subside, as the data is starting to suggest.

Nov 8 2024 (3 Shifts): Tariffs and the economy under a new administration

Aug 30 2024 (3 Shifts): Rate cuts are coming in the US