Key Points:
- The Fed cut rates by 25 basis points to 4.25%-4.50%.
- There’s zero change to commitment to 2% inflation over time. The rate is just going to get there more slowly than previously thought.
- Passive quantitative tightening (balance sheet shrinkage and reduction in overall money supply) is ongoing.
- The Fed now sees 2 rate cuts next year, compared to 4 previously.
Hotter Inflation:
After cutting rates by a full point, the Fed thinks policy is in a much better place. It remains materially restrictive, but far less so. Per Powell, they can now be “more cautious on more adjustments to policy.” This commentary was related to slower inflationary progress in September and October readings (November was better). While Powell sees the overall disinflationary story as intact, he wants faster improvement. The somewhat disappointing pace led to an upward revision in the Personal Consumption Expenditures (PCE) index estimates for 2025 from 2.1% to 2.5%. This now implies that PCE will rise from 2.4% to 2.5% Y/Y. Core PCE is expected to be 2.5% next year vs. 2.2% in the last summary of economic projections (SEP). Encouragingly, this still represents Y/Y progress from 2.8% to 2.5%, meaning the PCE rise is via volatile food and energy costs, rather than something more structural.
There are no changes to long-term PCE expectations of 2%.
Specific Notes on Inflation:
By inflationary category, Goods-level inflation actually reached the Fed’s goal, which leaves services as the straggler. Sticky housing services inflation is steadily falling. But? Just like for inflation overall, this progress is slower than the Fed is seeking. Powell thinks this is a key reason for delayed disinflationary progress. To me, that’s encouraging. Powell will explicitly tell you that real-time rent inflation is far lower than the Owners’ Equivalent Rent (OER) number used in Fed readings (they should change the methodology). What’s important is that this stubborn obstacle on our way to 2% inflation has real-time readings that still point to continued progress. Timing is uncertain, but the eventual outcome is inevitable.
Other Important Inflationary Notes:
- Powell again said he sees more labor market slack today vs. 2019. He does not think wage inflation is a meaningful reason for the slower progress.
- There will be help next year from easier Y/Y inflation comps, as we lap lower readings, as well as distancing ourselves from the avian flu outbreak and a rough hurricane season.