The Federal Reserve: Waiting for more policy clarity

Chief Economist Eugenio J. Alemán discusses current economic conditions.

This week, and according to many, Federal Reserve (Fed) officials jumped onto the uncertainty bandwagon, along with consumers and businesses, waiting for more policy clarity from the Trump administration – and who could blame them with policies in daily flux? But this is not quite correct, even back in December, when the Fed released the Summary of Economic Projections (SEP) and the dot plot, it was clear that uncertainty had already permeated its decision as it postponed the achievement of the inflation target by one year, from 2026 to 2027, as we indicated at the end of December of 2024.

It is true that this time around there was an increased number of Fed members who were more hawkish than in December 2024, as shown in the dot plot comparison below, but the vast majority of them remained in the two rate cuts camp for this year, which is what they had deemed necessary for 2025 after the December 2024 meeting. And if inflation increases more and stays high for longer, which is not the Fed’s base case today, we may see more Fed members jumping onto the more hawkish bandwagon. For now, the dovish members of the Fed seem to be ‘well-anchored.’

Here we go again: ‘Stagflation’ and ‘temporary’ making a comeback

First, let’s tackle the ‘temporary’ issue head-on. Since the Fed beat inflation back in the early 1990s, every inflation episode had been a temporary episode so Fed officials had a very good reason to believe that the 2021-2022 inflation burst was also going to be of the ‘temporary’ kind. They were wrong, and we explained the reasons in previous weekly reports. Case closed.

However, during the press conference after Wednesday’s FOMC decision, the Fed Chairman was challenged by a reporter on whether the Fed was going to be wrong again this time, as it was during the recovery from the pandemic when it also thought that the inflation episode was going to be temporary. Who knows? However, the job of a central bank, of the Federal Reserve, is to convey that it is in charge and will do whatever it takes to bring inflation back in line with its objective – and that is what the SEP is showing.

The SEP reflected an increase in the headline PCE price index estimation for 2025 and 2026 but no change in the estimation for the core PCE price index for 2026, which means that Fed officials estimate that core prices will continue their disinflationary path after experiencing a temporary tariff-induced increase in 2025. And this is what temporary means: it means that the Fed is okay with watching the headline PCE price index increase for some time as long as the core PCE price index continues to come down or remains stable.

What the SEP shows every time it is released is what is typically called “guidance.” It is what the Fed expects to see from where it stands today (and in the future) in terms of its monetary policy. This means that the Fed continues to consider current monetary policy (as well as future monetary policy) consistent with the achievement of the 2.0% inflation target.

Now let’s take on the stagflation issue. We have explained this issue in the past, so we recommend reviewing our previous reports on the topic as a refresher. However, the resurgence of this issue, which has been front and center in financial reporting lately seems odd, very odd. Financial reporting as well as overall reporting is prone to using catchy headlines or phrases to entice readership, we understand this. And the word stagflation is a catchy (scary?) word in the financial industry, so we believe it is used exaggeratedly.

As we argued before, the fear of stagflation was wrong during the recovery from the pandemic recession and is wrong today. And the Fed has the necessary tools to prevent stagflation. Not that stagflation cannot occur ever again, but we are convinced that the Fed learned the lessons from the 70s and 80s and is in a much better state of mind, and knowledge, to prevent such an event to repeat.

At the same time, the new SEP’s economic forecast expects Q4/Q4 2025 GDP growth at 1.7% with growth for 2026, 2027, as well as longer term, settling at 1.8%, hardly a rate of growth that could be called stagnant. It is more the realization that many of the policies being implemented today could lower shorter-term potential economic growth for the US economy to 1.8% rather than the Fed’s previous rates of 2.0% and 1.9%, for 2026 and 2027.

Furthermore, although inflation has been pushed higher in the SEP, it is hardly a large increase, which means that the central bank is confident even in the current environment of high policy uncertainty. And no, this is not a stagflation episode.

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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.

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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.

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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