By Steven K. Beckner
(MaceNews) – Federal Reserve officials reaffirmed their sense of caution about the future course of monetary policy in wake of a surprisingly strong December employment report, which was widely interpreted as greatly diminishing hopes for interest rate cuts this year.
Officials were already speaking hesitantly about resuming monetary easing, variously calling for “patient,” “gradual” and “cautious” approaches toward further cuts in the federal funds rate, but
such feelings seem to have been augmented since last Friday, when the Labor Department reported stronger than expected job and wage gains last month, as well as a plunge in the unemployment rate.
New York City Federal Reserve Bank President John Williams was vague about where the Fed’s policymaking Federal Open Market Committee will be taking rates Wednesday, but hinted there is no hurry to change the funds rate, given great uncertainty about the outlook and given that getting inflation down to the Fed’s 2% target “will take time.”
Minneapolis Fed President Neel Kashkari suggested the Fed may have to keep the short-term interest rates it controls higher to the extent that better productivity growth has driven up the “neutral” rate.
Kansas City Federal Reserve Bank President Jeff Schmid said the funds rate may already be at neutral.
On the other hand, Chicago Fed President Austan Goolsbee expressed great optimism about the inflation outlook, suggesting he may be more prone to rate cuts than others.
Many observers were looking for further cooling of the labor market, along with moderation of inflation, in the hope that the FOMC might see fit to continue cutting the funds rate after 100 basis pints of easing in 2024.
But such hopes were dashed when the Bureau of Labor Statistics announced that non-farm payrolls grew by 256,000 new jobs in December, far more than expected and up from 212,000 in November. It also reported that the unemployment rate fell a tenth to 4.1%. Average hourly earnings rose 0.3% or 3.9% from a year earlier – nearly twice the Fed’s 2% inflation target.
At the Dec. 18 meeting, when the FOMC cut the funds rate for a third time to a target range of 4.25% to 4.50%, participants projected two additional 25 basis point reductions this year — half as many as anticipated in their September Summary of Economic Projections.
But in wake of the December employment report, many Fed watchers are now forecasting only one 25 basis point cut and not until later in the year. Some even began speculating about a possible policy reversal that could bring rate hikes. The report reinforced an uptrend in bond yields.
Wall Street turned more cheerful Wednesday morning after the Labor Department released mixed inflation data. Its consumer price index rose 0.4% in December and 2.9% from a year ago – up from 2.7% in November. The core CPI moderated a bit from to 3.2% year-over-year after four straight 3.3% increases, after climbing 0.2% last month. Previously, the producer price index was reported up a less-than-expected 0.2% last month, but a higher 3.3% from a year earlier. And it was noted by some that core PCE categories like domestic and international airline fares were up much more than expected.
In its Dec. 18 policy statement, the FOMC signaled that further cuts in the funds rate are likely to be more limited, and Chair Jerome Powell reinforced the impression by saying the FOMC would be proceeding “slowly” and “cautiously” as they seek to balance their goals of “maximum employment” and returning to “price stability.”
Minutes of the mid-December meeting, released Wednesday, confirmed that most FOMC participants were predisposed to pause rate cuts. There was division, but “a substantial majority of participants observed that, at the current juncture, with its policy stance still meaningfully restrictive, the Committee was well positioned to take time to assess the evolving outlook for economic activity and inflation, including the economy’s responses to the Committee’s earlier policy actions.”
Ahead of the FOMC’s next meeting of January 28-29, officials have continued to sound hesitant about resuming monetary easing.
On Wednesday, Williams trod carefully in remarks at a CBIA Economic Summit and Outlook conference.
“The economy is in a very good place and has returned to balance, as have the risks to the two sides of our mandate,” the FOMC vice chairman said. “Because that balance has now been achieved, our job is to ensure the risks remain in balance.”
Williams spoke with some trepidation about inflation. “While I expect that disinflation will progress, it will take time, and the process may well be choppy.”
He said monetary policy is “well positioned to keep the risks to our goals in balance,” but said “the path for monetary policy will depend on the data,”
Although the economy is “in a good place,” Williams said the economic outlook is “highly uncertain, especially around potential fiscal, trade, immigration, and regulatory policies.”
Kashkari, a 2025 FOMC voter, called the economy “resilient” despite a “tight” monetary policy and indicated that rates may have to stay relatively high so long as faster productivity growth is driving up the “neutral” rate.
FOMC participants increased their estimate of the “longer run” or “neutral” funds rate, which includes the Fed’s 2% inflation target plus a hypothetical “real” rate, by some six tenths to 3.0% in December.
At the Minneapolis Fed’s 2025 Regional Economic Conditions Conference, Kashkari said, “productivity growth now seems higher,” although he said he’s “not sure that’s going to be continued.” He said this drives up demand for capital, which tends to push up real interest rates and in turn the “neutral” funds rate.
“I feel like we are takers, we are recipients, of this broader macroeconomic environment that we’re in, that we’re having to navigate around,” he said. “So, if this neutral rate, which we debate a lot, if the neutral rate is low we’ll move monetary policy up and down around that neutral rate to achieve our dual mandate goals.”
“If the neutral rate is higher because we’re in a higher productivity environment then we’ll move monetary policy around that higher neutral rate,” Kashkari continued. “But we don’t believe that we can set that neutral rate. We feel that we’re takers of that neutral rate, and we have to try to figure out what that neutral rate is, which is imperfect at best.”
Asked if the FOMC’s rate decisions are also influenced by federal budget deficits and their effect on bond yields, Kashkari replied, “For sure, for sure, for sure.”
Coincidentally, the Cleveland Fed released research Wednesday showing that “US productivity may be on a higher growth trajectory than previous estimates,”
Goolsbee, reacting to the CPI report, suggested that the inflation picture may be even better than the numbers indicate because higher first quarter 2024 price increases will be “falling out” in calculations of year-over-year inflation gauges in coming months.
“I still see continued progress,” he asserted in a Midwest Economic Forecast Forum webinar.
Goolsbee, who will also be voting on the FOMC this year, added, “It’s important to take the long view .… The trend continues to be improvement in inflation.”
Usually thought of as one of the more “dovish” Fed district bank presidents, he said “the key thing the Fed is looking for are signs the economy is overheating or stabilizing at a full employment level,” but went on to reiterate his previous belief that the economy is on a “golden path” of disinflation without recession, i.e. a “soft landing.”
Despite fears that tight labor markets would drive up wages and in turn prices, Goolsbee observed that “inflation did come down even though wage growth was high.”
As for whether policies of the incoming Trump administration will boost inflation, he said, “if Congress and the President begin drafting policies that are going to raise prices we’ll have to think about it.” But he said the Fed can’t prejudge the impact of policy changes.
A past skeptic of the Fed’s 2% inflation target, he declared, “We will get it to 2%, because that’s a promise we made.” And he said that target helped keep inflation expectations low even when it was approaching 10%.
While generally upbeat about the economy, Goolsbee noted that credit delinquencies have reached a “high” level, and “that area of the house is of some concern to me.”
Goolsbee had little to say about interest rates, but in contrast to other officials, he said, “I still think neutral is below where we are now .…”
Responding to a question about mortgage rates, he said, “de facto I do think rates are going to be higher than before…” because “we’ve been in a restrictive funds rate environment.”
He said “higher rates are tough for housing,” and said “going back to a more normal rate environment” will help the housing market, but he also pointed to tight supply conditions in the housing market.
Schmid, another 2025 FOMC voter, reiterated his belief that the funds rate is already near where it needs to be over the longer run on Tuesday.
“With inflation close to target and growth showing continued momentum, I believe we are
near the point where the economy needs neither restriction nor support and that policy should be
neutral,” he said, adding that “there are many good reasons to expect that interest rates might settle at a higher neutral rate than we saw before the pandemic.”
Schmid also warned that “interest rates could also settle higher on account of the continued
deterioration of the U.S. fiscal position and an abundance of Treasury borrowing that needs to be financed.”
So, “interest rates might be very close to their longer-run level now,” he said.
“Regardless, I am in favor of adjusting policy gradually going forward and only in response to a sustained change in the tone of the data,” Schmid went on. ”The strength of the economy allows us to be patient.”
Schmid also repeated his advocacy of continued balance sheet shrinkage to “reduce the Fed’s footprint in financial markets.”
Noting that the Fed has been shrinking its balance sheet for over two years, he said, “I would like to see even further declines this year.”
“Also, I would prefer that we move towards holding only Treasuries in our portfolio in line with previous communications from the FOMC,” Schmid said, adding that the Fed should “move out
of mortgage-backed securities” and should avoid “using our balance sheet to intervene in any other asset classes.”
Even before the December job and inflation data, a mood of caution had grown among Fed officials. Late last week, yet another 2025 voter, St. Louis Fed President Alberto Musalem said further rate cuts would “have to be gradual – and more gradual than I thought in September.”