Fed meeting: no need to raise rates

The Fed concluded their latest meeting yesterday. In the press conference, Jerome Powell dismissed the notion that the Fed may need to raise rates again in several answers to questions. Leading up to the meeting, some commentators had thought that because the economy continues to perform despite the Fed’s large raising campaign, that the Fed may need to raise rates again. Powell re-emphasized that he thinks interest rates are restrictive and will eventually slow the economy once past their long and variable lags. This was somewhat more dovish than the market expected and the 2-year yield fell five basis points from before the meeting. I was surprised at how dovish Powell was at this meeting given that core PCE inflation has risen 4.4% annualized over the last three months.

I note three other interesting comments from Powell about hot topics of the moment:

1. Powell summarily dismissed stagflation talk by making the comparison to when stagflation was real in the 1970’s. He answered a question from Claire Jones of the Financial Times,

Q: The Q1 GDP print has led some to start mentioning the term “stagflation” with respect to the U.S. Economy. Do you or anyone else on the FOMC think this is now a risk?

A: I guess I would say I was around for stagflation and it was 10% unemployment, it was high single digits inflation, and very slow growth. Right now, we have 3% growth which is pretty solid growth, I would say by any measure. And we have inflation running under 3%. I don’t really understand where that is coming from. In addition, I would say most forecasters, including our forecasting was that last year’s level of growth was very high; 3.4% in the fourth quarter, and probably not going to be sustained and will come down. But that would be our forecast, that wouldn’t be stagflation. That would still be to a very healthy level of growth. And of course with inflation, we will return inflation back to 2%. I don’t see the ‘stag’ or the ‘flation.’

2. Powell was dismissive on the question of if the neutral real rate is higher than it was before the pandemic. From a question from Michael McKee of Bloomberg,

Q: The vice chair of the FOMC said recently that he’s willing to consider the idea that potential growth has moved up and of course he’s Mr. potential growth/r-star. Do you share that view and would that imply that maybe policy isn’t tight enough?

A: So, I think I would take that question this way. We saw a year of very high productivity growth in 2023 and we saw a year of I think negative productivity growth in 2022. So, I think it’s hard to draw from the data. There are two questions: one is will productivity run you know persistently above its longer run trend? I don’t think we know that. In terms of potential output though. That’s a separate question. We’ve had what amounts to a significant increase in the potential output of the economy that’s not about productivity. It was about having more labor frankly both in 2023 both through participation and also through immigration. We’re very much like other forecasters and economists getting our arms around what that means for potential output this year and next year and last year for that matter too. So, I think in that case, I think you really do have a significant increase in potential output but you’ve also got more supply. Those people also come in, they work, they have jobs, they spend, so you’ve also got demand. It may be that you get more supply than you get demand at the beginning but ultimately it should be neither inflationary nor disinflationary over a longer period.

3. One of the reasons why Powell expects inflation to fall further this year is from the expected lag from rent inflation. Powell explained a component of why rent inflation lags other inflation. From a question from Courtenay Brown of Axios,

Q: How confident are you that rent inflation will be helpful in the coming months?

A: So, essentially there are a number of places in the economy where there are lag structures built into the inflation process. Housing is one of them. When a new person goes to rent an apartment, that is called market rent and you can see that market rents are barely going up at all. Inflation in those is very low. Before that, they were incredibly high. They sort-of led the high part. What happens is, those market rents take years actually to get all the way into rents for tenants that are rolling over their leases. Landlords don’t tend to charge as much of an increase to a roll-over tenant for whatever reason. And what that does is build-up a sort-of unrealized portion of increases when there have been big increases. It is complicated, but the story is that it just takes some time for that to get in. Now, I am confident that as long as market rents remain low, this is going to show up in measured inflation, assuming that market rents do stay low. What will be the exact timing of it? I think we’ve learned that the lags are significantly longer than what we thought at the beginning. So, [I’m] confident that it will come [down] but not so confident in the timing of it.

Powell did a good job at refuting many of the narratives that have crept up because interest rates have risen and inflation has been higher. It reminds me of last October where many of the same ideas were being discussed as to why rates were rising. Many forget (some want to forget) that the primary driver of Treasury interest rates is the outlook for inflation and growth. A weakening in the economic data will bring interest rates back down and interest rate cut expectations back closer.

Quotes have been self-transcribed.