Did the Federal Reserve cut interest rates too early? All the leading indicators – whether the headline inflation data or the fine points in monthly reports – suggest the Eccles Building kicked off the easing cycle too prematurely. Of course, the Fed will do what it does best: shift the goalposts and use other inflation metrics to support the case for loosening monetary policy conditions.
Federal Reserve Digests the Data
The December Summary of Economic Projections, a quarterly survey of Federal Reserve officials and their views on the economy and policy, revealed a hawkish stance at the US central bank. While they have cut interest rates a full percent since September, policymakers will mostly sit on their hands this year. In 2025, the Fed is expected to pull the trigger on two quarter-point interest rate cuts, down from the initial estimate of two 25-basis-point reductions to the benchmark federal funds rate. Investors anticipate a rate pause at the January Federal Open Market Committee meeting.
Fed Chair Jerome Powell confirmed that the shift in tone was fueled primarily by inflation risks. A summary of the policy meetings indicated that participants are concerned about current inflation threats and the incoming administration’s proposed changes to immigration and trade. President-elect Donald Trump has proposed universal tariffs on all US imports, hefty levies on Chinese goods entering the country, and mass deportations.
Though Trump has outlined a blueprint, his public policy pursuits are not set in stone. Therefore, everything is speculative, making it difficult to craft forecasts or design monetary policy. For now, market observers can only comb through the data and find inflation is making a comeback.
As Liberty Nation News has reported, all the key inflation reports – the consumer price index, the producer price index, and the Federal Reserve’s preferred personal consumption expenditure price index – have risen since the Fed launched its rate-cutting cycle. The next set of readings is also expected to inch higher, according to the Cleveland Fed’s Inflation Nowcasting model.
Economists reviewed two other notable reports and discovered the same trend: renewed inflationary pressures. The Institute for Supply Management (ISM) recently published its monthly manufacturing and services surveys, and the study's authors concluded price pressures surged in December. Manufacturing prices expanded for the 11th month this year, while services prices went gangbusters in December and increased at the highest pace since January 2024.
The December jobs report was also consequential for various parties. The US economy created 256,000 new jobs to end the year, topping economists' expectations of 160,000. The unemployment rate slipped to 4.1% from 4.2%. Nominal (non-inflation-adjusted) average hourly earnings growth remained solid, rising 0.3% monthly but easing below 4% year over year.
The hot figures fueled a rise in US Treasury yields, with the 10-year eyeing 5% and the 20- and 30-year yields topping 5%, respectively. The US Dollar Index (DXY), a metric of the buck against a weighted basket of six currencies, spiked. US stocks tanked faster than Vice President Kamala Harris’ election odds. Metals and energy soared.
Remember, the Fed took its eye off the inflation ball to concentrate on the maximum employment side of its dual mandate, thinking the monetary authorities were within reach of restoring the institution’s 2% objective. This does not elicit confidence in the central bank’s forecasting abilities, particularly as the money supply rocketed every month in 2024.
So, while a chorus of economists is penciling in higher inflation in the coming year, the Federal Reserve has espoused confidence that inflation is traversing sustainably to 2%. Of course, officials can endorse this concept when they shift the goalposts whenever it suits a narrative.
CPI? Supercore? Wages?
Kevin Warsh, a former Fed governor and likely successor to Jerome Powell, was befuddled when Powell followed through on a jumbo half-point interest rate cut in September. “The Fed doesn't seem to have a serious theory of inflation," he told CNBC in October. Indeed, as Warsh noted, over the past few years, the Fed has altered what gauges it concentrates on to determine how inflation is performing and how it can guide policymaking efforts.
Officials championed flexible average inflation targeting. Later, they touted the efficacy of core personal consumption expenditure (PCE) data. This strips the volatile energy and food categories from the equation, and the PCE broadens the coverage of expenses and frequently adjusts weights. It is running close to 3%. After the coronavirus pandemic, the Fed homed in on a new category called supercore inflation: services ex-housing. This is in the 4%-5% range. Wages were considered an inflation metric, with policymakers supporting 3% growth. They are now at about 4%.
Fed Gov. Christopher Waller, a typical realistic and forthright presence at the central bank, reiterated his support for continued rate cuts in 2025, citing his confidence in lower inflation. He extolled the smaller-than-expected PCE figures for November, six-month underlying inflation trends, and prices estimated rather than observed when calculating inflation.
“If the outlook evolves as I have described here, I will support continuing to cut our policy rate in 2025,” Waller said. “The pace of those cuts will depend on how much progress we make on inflation, while keeping the labor market from weakening.”
The Fed thinks policy is restrictive enough to clamp down on inflation without triggering a recession. However, if the past is a glimpse of the future, the Fed might have made a mistake when cutting interest rates. The data indicate that the consumer price index mirrors the trends of the last major inflation episode from the 1960s to the 1980s.
Speaking to reporters at last month’s post-meeting press conference, Powell shot down the idea of a rate hike. If the inflation flame is rekindled, the Fed might have to consider one. Or, at the very least, leave interest rates higher for longer. If GDP growth is intact and the US labor market is not crashing, why not?
Stick a fork in it. The Fed pivot is done.
Sorry, Donald Trump
Is President Joe Biden and Fed Chair Jerome Powell presenting President-elect Donald Trump with a parting gift? Recent estimates indicate the US job market is poised for sizable downward revisions. Inflation could signal that the incoming administration is poised to endure a bout of above-trend numbers, prompting blame from the pearl clutchers in the Fourth Estate and Congress. Tariffs will inevitably result in one-time price hikes. The perpetual cause of inflation will remain government spending and Fed printing.
.jpg&w=1920&q=75)
