1. The Fed paused its cutting cycle today in light of strong inflation data and increased policy uncertainty.
2. We hold on to our view of March as a further hold--Powell seemed to point in that direction by saying that the Fed need not be "in a hurry" to adjust rates.
3. In any case, the main variable that will determine the Fed's path over the next two quarters will be trade policy: the broader the tariffs, the higher the rate outlook.
4. Our current base case is for a further cut in May, but we have low confidence--aggressive trade, immigration, or fiscal policy could easily overwhelm the Fed's path.
5. Despite his outright refusal to be drawn into a response to Trump, we view it as largely inevitable that tensions between the Fed and the administration will escalate over the next six months.
Details below:
Today's hold was widely expected, but the statement was still hawkish, as it removed language around inflation having "made progress toward the Committee's 2 percent objective." It retained language about inflation remaining "somewhat elevated."
In the press conference itself, Powell was less fixated on the point and indicated that the new language was not intended as a "signal" to markets.
We would also not worry too much about semantics. Powell also claimed, for example, that the Fed sees risks to both sides of the mandate as balanced, which we doubt is true: inflation is clearly a bigger problem for the Fed than the labor market.
In the short term, it seems unlikely that encouraging data on inflation will come in on time for a March cut. When asked if he anticipated a cut at the March meeting, Powell claimed there was a "broad sense" in the FOMC that they need not be "in a hurry" to adjust the policy stance.
We view this as confirmation that a March cut is unlikely unless the economy nosedives between now and then. Only drastic policy action (of the sort narrowly avoided yesterday) could cause this.
But the FOMC's biggest problem is neither inflation nor the labor market: it is the fact that the administration is (probably) introducing a series of inflationary actions across different policy fields.
Powell identified four today: tariffs, immigration, fiscal policy, and regulatory policy.
He said next to nothing on regulatory policy, which is probably fair, since it is unlikely to meaningfully impact the macroeconomic variables the Fed cares about. Fiscal policy is too far in the distance for Powell to say anything credible about it--and he generally avoids getting involved in any case.
Which leaves us with tariffs and immigration--perhaps surprisingly, Powell took a different stance on the two.
On immigration, it seemed clear that Powell thinks the administration's policy change is real and already impactful. Powell cited "anecdotal" evidence from the construction industry that businesses are struggling to recruit workers--possibly a reference to multiple concerns expressed in the recent Beige Book.
For now, Powell claimed that the labor market is not a significant contributor to inflation, which is true. But the anecdotal evidence would suggest that the risks to the labor market are much closer to symmetrical than they were six months ago.
Labor market tightness is an area to watch (current V/U ratio 1.18, see below) and can certainly be affected by Trump's stronger approach to immigration enforcement.
By contrast, Powell had very few concrete points to say about tariffs other than "we are only just beginning to see, and actually are not beginning to see much."
Later in the press conference, Powell explained that the range of outcomes for trade policy is "very, very wide. We don't know what is going to be [subject to tariffs]. We don't know for how long, how much, what countries, and we don't know about retaliation, or how it will transmit through the economy to consumers."
That last bit is a little disingenuous--surely the 400 PhD economists the Fed employs can figure out if a trade war is going to be inflationary or not. Powell is just afraid to say it out loud.
This is because it is a matter of Orwellian truth in Washington policy circles that tariffs do not cause inflation--every Trump nominee has to recite this at their confirmation hearing and incoming Commerce Secretary Howard Lutnick did so in the Senate today.
So Powell's (and the FOMC's) hands are in effect tied--they are politically barred from anticipating tariffs too far in advance and in any case find themselves in the same state of confusion as most of America's trading partners.
The direct consequence for monetary policy is that they cannot be proactive in tightening the monetary policy stance even if they know (as they do with immigration) that a policy is coming and is likely to be inflationary.
Instead, the FOMC will have to wait for it to take place, remain in place, and cause the inflation before they can act. Or at the very least, they will need to find a different excuse to hike rates (inflation expectations, anyone?).
In the end, we believe that if the tariffs are broad and/or escalating, this FOMC will not hesitate to (i) extend its pause and (ii) hike rates if necessary, despite the obvious political costs. We are just too close to the last shock for Powell to head into retirement with inflation getting out of control again.
Despite multiple attempts to bait him, Powell refused to be drawn into an outright rebuke of President Donald Trump's recent instructions.
Instead, he diplomatically said that it is "not appropriate" for him to respond to the president and that he had no contact with him.
Shortly following the end of the press conference, Trump wasted no time in publishing an attack on Powell and the Fed on his social media platform, Truth Social.
All best,
Dimitris and the Aurora team.
Upcoming travel:
Washington, DC - Mar 2-4
To book a meeting with me to discuss these or any other Aurora themes contact juliet@auroramacro.com
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