Economic Monitor – Weekly Commentary
by Eugenio Alemán

Fed holds steady: No news is good news

January 31, 2025

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 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 last performance may not be indicative of future results.

Consumer Price Index is a measure of inflation compiled by the U.S. Bureau of Labor Studies. Currencies investing are 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.

The National Federation of Independent Business (NFIB) Small Business Optimism Index is a composite of ten seasonally adjusted components. It provides a indication of the health of small businesses in the U.S., which account of roughly 50% of the nation's private workforce.

The producer price index is a price index that measures the average changes in prices received by domestic producers for their output. Its importance is being undermined by the steady decline in manufactured goods as a share of spending.

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