What they need to commence rate cuts
Powell noted that if the economy evolves broadly as expected (inflation continuing to decelerate further and economic activity moving closer towards trend growth), then it will be “appropriate to begin dialing back policy restraint at some point this year.”
While this admission will not have surprised anyone, the FOMC’s requirement that they gain “greater confidence that inflation is moving sustainably towards 2%” before cutting rates likely confounded many market participants. After all, with core PCE already trending around 2% at the six-month and three-month annualized levels, what exactly does the Fed require to gain greater confidence? Does this imply that they need additional months showing core PCE at 2%, or will they only feel comfortable once there is clear evidence of slower economic growth?
Unsurprisingly, those questions dominated the press conference. Powell offered only slightly more color and very little clarity.
On inflation, he said they do have confidence that inflation is trending towards 2% but need “greater” confidence. Although the Fed already has six months of inflation data indicating that inflation is heading to 2%, Powell noted that they need “more.” Unfortunately, no clarity was given on how Powell defines “more.” Still, he did emphasize that much of the improvement in inflation to date has come from core goods inflation, so now the improvement needs to come from services inflation.
On the economy, Powell noted three rather different ideas. 1) They do not view strong growth or a strong labor market as an obstacle to inflation falling further. 2) The key risk from strong growth is that inflation stabilizes at a level above 2%, not that it resurges again. 3) Unexpected labor weakness could bring forward the rate cutting timeline.
Finally, after having tussled with those concepts for a while, Chair Powell explicitly noted, “I don’t think it’s likely that the committee will reach a level of confidence by the time of the March meeting.” Unless the labor market deteriorates suddenly or sharply, a March cut is essentially off the table.
Side note: Fed balance sheet
In recent weeks, several FOMC members have commented on the need to consider slowing the pace of balance sheet run-off (quantitative tightening). Addressing this, Powell said that while policymakers have begun discussing the topic, they plan to have a deeper discussion at the next meeting.