Fed holds steady: No news is good news

Chief Economist Eugenio J. Alemán discusses current economic conditions.

In the aftermath of this week’s Federal Open Market Committee (FOMC) decision to hold the fed funds rate unchanged (which was what markets were expecting), markets and analysts concluded that Federal Reserve (Fed) members had changed their views on inflation and that they no longer expect the disinflationary process to continue. According to this interpretation, rates would either stay as they are today for longer or, need to be increased if, in fact, the disinflationary process stalls and/or if inflation starts to increase again.

However, we are not convinced that anything changed in the Fed members’ views since their December 2024 decision, as we argued in the write-up we sent after the Fed’s decision. Although there are plenty of risks that could keep the Fed from lowering the fed funds rate soon or even cause it to consider increasing it, Fed officials have no problem with the path of interest rates they set in December or with the disinflationary process according to our reading. We continue to believe that the Fed is still okay with lowering the federal funds rate twice during this year. Of course, as it likes to say, it will remain “data- dependent,” which means it will adjust the path if it is compelled to do so because of incoming data.

As we argued after the December 2024 decision, Fed officials “extended the runway” for achieving the 2.0% PCE price index target from 2026 to 2027, recognizing that the path toward the target may be delayed a bit more than they had expected. The reason for this extension could be related to potential changes in policies, i.e., tariffs, immigration, etc., or related to consumers and business inflationary expectations, or a combination of both of these factors. That is, all these new policies have the potential to keep inflation higher than expected and for a longer period. However, this is not a problem for the Fed, as the extension of the runway could be considered normal procedure when central banks use an inflation target to conduct monetary policy.

As an example, consider what happened after the 2008 Great Financial Crisis and before the pandemic, when, for more than a decade, the Fed struggled to bring inflation up to the 2.0% target for a sustainable period of time and had to introduce several new monetary policy instruments, i.e., Quantitative Easing (QE) and others, to fight global deflationary trends as shown in the graph below. These trends were so strong that the European Central Bank (ECB) not only implemented QE, but also tried a novel approach called “negative interest rates,” which had never been tried in the history of central banks and which the Fed has never implemented in the US.

During this period, the Fed had to fight many out of its control trends that were pushing inflation below the 2.0% target, and close to deflationary levels. Fighting deflation is a bigger challenge for central banks than having to fight high inflation. Central banks know what they have to do to contain inflation, but deflationary forces are more difficult to contain and manage.

These forces were pushing the “term-premium” downward during this period while today, the term- premium is doing just the opposite. Thus, the Fed did not need to fight markets to keep interest rates low for a very long period of time during that period. Today, it is just the opposite. In some sense, this is good for the Fed because, as we have said before, it could bring down interest rates (at the lower end, which is the only one the Fed controls) without creating a new monetary cycle, i.e., a lending cycle, that could jeopardize the inflation fight because markets are keeping long-term rates higher.

In summary, we recommend not to over psychoanalyze the Fed’s FOMC decision in January because, in some sense, “no news is good news.”

Economic and market conditions are subject to change.

Opinions are those of Investment Strategy and not necessarily those of Raymond James and are subject to change without notice. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. There is no assurance any of the trends mentioned will continue or forecasts will occur. Past performance may not be indicative of future results.

Consumer Price Index is a measure of inflation compiled by the US Bureau of Labor Statistics. Currencies investing is generally considered speculative because of the significant potential for investment loss. Their markets are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising.

Consumer Sentiment is a consumer confidence index published monthly by the University of Michigan. The index is normalized to have a value of 100 in the first quarter of 1966. Each month at least 500 telephone interviews are conducted of a contiguous United States sample.

Personal Consumption Expenditures Price Index (PCE): The PCE is a measure of the prices that people living in the United States, or those buying on their behalf, pay for goods and services. The change in the PCE price index is known for capturing inflation (or deflation) across a wide range of consumer expenses and reflecting changes in consumer behavior.

The Consumer Confidence Index (CCI) is a survey, administered by The Conference Board, that measures how optimistic or pessimistic consumers are regarding their expected financial situation. A value above 100 signals a boost in the consumers’ confidence towards the future economic situation, as a consequence of which they are less prone to save, and more inclined to consume. The opposite applies to values under 100.

Certified Financial Planner Board of Standards Center for Financial Planning, Inc. owns and licenses the certification marks CFP®, CERTIFIED FINANCIAL PLANNER®, and CFP® (with plaque design) in the United States to Certified Financial Planner Board of Standards, Inc., which authorizes individuals who successfully complete the organization’s initial and ongoing certification requirements to use the certification marks.

Links are being provided for information purposes only. Raymond James is not affiliated with and does not endorse, authorize or sponsor any of the listed websites or their respective sponsors. Raymond James is not responsible for the content of any website or the collection or use of information regarding any website's users and/or members.

GDP Price Index: A measure of inflation in the prices of goods and services produced in the United States. The gross domestic product price index includes the prices of U.S. goods and services exported to other countries. The prices that Americans pay for imports aren't part of this index.

Employment cost Index: The Employment Cost Index (ECI) measures the change in the hourly labor cost to employers over time. The ECI uses a fixed “basket” of labor to produce a pure cost change, free from the effects of workers moving between occupations and industries and includes both the cost of wages and salaries and the cost of benefits.

US Dollar Index: The US Dollar Index is an index of the value of the United States dollar relative to a basket of foreign currencies, often referred to as a basket of U.S. trade partners' currencies. The Index goes up when the

U.S. dollar gains "strength" when compared to other currencies.

Import Price Index: The import price index measure price changes in goods or services purchased from abroad by U.S. residents (imports) and sold to foreign buyers (exports). The indexes are updated once a month by the Bureau of Labor Statistics (BLS) International Price Program (IPP).

ISM Services PMI Index: The Institute of Supply Management (ISM) Non-Manufacturing Purchasing Managers' Index (PMI) (also known as the ISM Services PMI) report on Business, a composite index is calculated as an indicator of the overall economic condition for the non-manufacturing sector.

Consumer Price Index (CPI) A consumer price index is a price index, the price of a weighted average market basket of consumer goods and services purchased by households.

Producer Price Index: A producer price index(PPI) is a price index that measures the average changes in prices received by domestic producers for their output.

Industrial production: Industrial production is a measure of output of the industrial sector of the economy. The industrial sector includes manufacturing, mining, and utilities. Although these sectors contribute only a small portion of gross domestic product, they are highly sensitive to interest rates and consumer demand.

The NAHB/Wells Fargo Housing Opportunity Index (HOI) for a given area is defined as the share of homes sold in that area that would have been affordable to a family earning the local median income, based on standard mortgage underwriting criteria.

Conference Board Coincident Economic Index: The Composite Index of Coincident Indicators is an index published by the Conference Board that provides a broad-based measurement of current economic conditions, helping economists, investors, and public policymakers to determine which phase of the business cycle the economy is currently experiencing.

Conference Board Lagging Economic Index: The Composite Index of Lagging Indicators is an index published monthly by the Conference Board, used to confirm and assess the direction of the economy's movements over recent months.

New Export Index: The PMI New export orders index allows us to track international demand for a country's goods and services on a timely, monthly, basis.

Gold is subject to the special risks associated with investing in precious metals, including but not limited to: price may be subject to wide fluctuation; the market is relatively limited; the sources are concentrated in countries that have the potential for instability; and the market is unregulated.

The Conference Board Leading Economic Index: Intended to forecast future economic activity, it is calculated from the values of ten key variables.

Source: FactSet, data as of 12/6/2024