Taking Time, More Confusion. Back in September (our note is here) we wrote that the outcome of the FOMC was “hard to rationalize”. The FOMC was cornered in November, and the only thing was to cut again. Powell took time and said that one or two months of data cannot change their minds – see Q&A part below for exact quote. While we agree with the approach (never overreact to the data), we see an issue now. When thinking about the December SEP, in our view the FOMC will project a stronger economy it did not only in September but also in June when it expected to cut only once in 2024. In other words, to us the FOMC today cut rates because… they said so in September but we do not understand why, conditional on their reaction function and the data, they should cut again in December. Alternatively, we are not sure there is an easy way to model their reaction function. We hoped Powell could clarify but he did not.
As for inflation, please note what Powell said replying to a question (see Q&A for exact quote), which in our view confirms that he is accepting the risk of remaining above target going forward.
The SEP issue
The figure below shows the September SEP. When thinking about the possible December 2024 SEP, we notice an issue. Right now, the most likely outcome is for the FOMC to raise the core PCE forecast to 2.8-2.9% in 2024 and maybe marginally higher in 2025. Also, GDP growth in our view is likely to be revised up well above 2% and the unemployment rate close to 4%. In other words, the December SEP in our view will show a stronger economy not only compared to the September SEP but crucially to the June SEP when the FOMC signaled only 1 cut in 2024. The question then becomes: what is the FOMC reaction function? We hoped to have some clarification from Powell today but instead, the Chair took time. In the end, we remain very puzzled.
Q&As
Question: Core PCE inflation is at 2.7% Why not pausing at this meeting?
Powell. “[…] if you look at 3 and 6-month core PCE, you’ll see they are around 2.3% […]. What this telling us is that we really have made significant progress, and we expect […] bumps. […] Where is it coming from? It’s not a very tight economy. […] we’re not declaring victory, obviously, but we feel like the story is very consistent with inflation continuing to come down a bumpy path over the next couple of years and settling around 2%. That story is intact, and it won’t be one or two really good or bad months of data to really change the pattern at this point, now that we’re this far into the process”.
Comment: Lots of words but the crucial part is “settling around 2%“. Translated: Powell knows that he cannot be sure to go back to 2% but he is accepting the risk. Also, he is telling us that the FOMC is not going to change its mind until, at least, early 2025.