The May 2024 FOMC round confirmed our “on hold”, “for longer”, and “no additional hike” thesis. No surprises in the outcome of today’s FOMC, Powell took time. Going forward, we reiterate our message: do not pay much attention to realized/published inflation (we know, that’s what everyone does..). Instead, pay a lot of attention to pi*, which already summarizes “the totality of the incoming data”, and provides the best signal about medium-term inflation dynamics.
Statement
“Lack of further progress”. The statement showed a relevant change on inflation, stressing the “lack of further progress”. Not a big surprise, given the data. Nevertheless, in line with the signals of the distributions.
The statement, of course, contained important information on the redemption cap. We follow the rules religiously, so we cannot cover that part.
Q&As
Question: Is policy sufficiently restrictive?
Powell. “I do think the evidence shows pretty clearly that policy is restrictive and is weighing on demand. And there are a few places I would point to for that. You can start with the labor market. So, demand is still strong, the demand side of the labor market in particular, but it has cooled from its extremely high level a couple of years ago, and you see that in job openings. You saw more evidence of that today and the jobs report as you’ll know, it’s still higher than pre pandemic but it has been coming down both in the Indeed report and the JOLTS report […]. The same is true of quits and hiring rates, which are essentially normalized. […] So, I do think it’s clear that policy is restrictive, sufficiently restrictive, I guess. So, I would say that we believe it is restrictive, and we believe over time it will be sufficiently restrictive, that will be a question that the data will have to answer. […] We’re committed to retain retaining our current restrictive stance of policy for as long as is appropriate and we’ll do that.”.
Comment: “Sufficiently restrictive” means “the inflation forecast converges back to 2% in a reasonable amount of time”. Clearly, the data have to validate it over time. For that to happen, pi* (shown below) needs to approach 2%. The problem here is always the same: there is no easy way neither to explain what pi* is, nor (most importantly) to answer the question “what do you need to see in the data to in/decrease your confidence?”. This is why, at every press conference Powell says something like “we look at the totality of the data”, which really means “pi*, the most comprehensive measure of underlying inflation, which is estimated using the totality of the data, needs to fall back to 2%”. In this moment, it is going roughly sideways, therefore the Fed assumes that by keeping rates at this level realized/published inflation will not re-accelerate and pi* will gently fall over time. As explained many times on these columns, it is virtually impossible to say what combination of incoming data (and when) can push pi* to 2%. What we can do is to update the estimate frequently and inform you.
Three questions about hiking again: Q1 What could make you raise rates at this point? Q2 Was there discussion about a rate hike at all in this meeting? Q3 Is there a time frame of persistent inflation that would trigger a rate hike?
Powell Q1. “I think it’s unlikely that the next policy rate move will be a hike. I’d say it’s unlikely. You know, our policy focus is really what I just mentioned, which is how long to keep policy restrictive. You ask, what would it take? You know, I think we’d need to see persuasive evidence that our policy stance is not sufficiently restrictive to bring inflation sustainably down to 2% over time. That’s not what we think we’re seeing, as I mentioned, but that’s something like that is what it would take. We’d look at the totality of the data to answer that question that would include inflation, inflation expectations, and all the other data”.
Powell Q2. “The policy focus has really been on what to do about how holding the current level of restriction”.
Powell Q3. “There isn’t any rule, you can’t look to a rule. You know… these are these are gonna be judgment calls”.
Comment: A huge victory for FRB-US and our February and April research (see here and here). A reminder: it is very, very complicated to see a hike from here, unless core PCE price inflation re-accelerates above 5% (or so). In all other scenarios (including a higher R*), the FRB-US model prediction is clear: no hike and “for longer”.
Question: Is potential (Y*) higher?
Powell. “There are two questions. One is: will productivity run 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. […] So 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. I think in that case, you really do have a significant increase in potential output. But you’ve also got, you’ve got more supply. Those people come in and they are working. They work, they have jobs, they spend so you’ve also got demand. So, it may be that you get more supply than demand at the beginning, but ultimately, it should be neither inflationary nor disinflationary over a longer period.”.
Comment: Another excellent call of FRB-US (see our January note here). As we have explained, the level of Y* is higher due to a positive supply shock on the labor market. About the slope of Y* (potential growth), the model suggests that it is slightly higher than pre-Covid (about 2 tenths to rounding).