Powell: Clueless on Inflation

Situation Worse Than He Had Suggested

To no one’s surprise, the Federal Open Market Committee lowered the Federal Funds rate by 25 basis points on Wednesday. The suspense, as last week’s SriKonomics discussed, had been only on how Federal Reserve Chairman Jerome Powell would explain his mutually contradictory conclusions — that inflation was more elevated than the central bank had forecast, while at the same time easing policy.

He did not disappoint as I watched his post-FOMC press conference. He provided no explanation that made sense. Powell admitted that recent inflation was running at a pace faster than expected. However, the Chairman said, “I would say today was a closer call, but we decided it was the right call because it was the best decision to foster achievement of both of our goals, maximum employment and price stability.”

Come again? You say that inflation is running ahead of Fed expectations and that leads you to reduce rates rather than pause and reflect? Of course, Powell may believe that as Chairman of the world’s largest economy’s central bank, he does not have to provide an internally consistent explanation of monetary policy decisions.

The reality was quite different.

With investors overwhelmingly anticipating yet another rate reduction as a gift from Uncle Jay during the Holiday Season, he was not going to disappoint them. However, with inflation turning upward before it had a chance to reach the 2% target, the Chairman coupled the rate reduction with a statement that future rate cuts would be slower and fewer — with the FOMC penciling in just two cuts during 2025 instead of the four cuts that members had anticipated as recently as September.

For the second time in three months, the FOMC decision was not unanimous. Cleveland Fed President Beth Hammack dissented from the call to lower rates further, saying in a statement yesterday, “I prefer to hold policy steady until we see further evidence that inflation is resuming its path to our 2% objective." This is a more cogent explanation compared with the majority decision to cut rates despite growing inflationary pressures.

Announcement of a rate reduction and, concomitantly, a warning about fewer future cuts in 2025, sent the equity market into a tailspin. The Dow Jones Industrial Average fell by more than 1,100 points on Wednesday. Major US equity averages fell by 2.5% or more, with the interest rate-sensitive NASDAQ index declining by more than 3.5%. The loss to investors holding 10-year Treasurys was just as remarkable. The yield rose by 12bp to 4.51% on Wednesday and further to 4.57% on Thursday. Recall that the yield had been almost a percentage point lower at 3.62% just before the first Fed rate cut on September 18.

Treasurys got a small reprieve yesterday with the 10-year closing at 4.53%. This was a consequence of PCE inflation — the Fed’s favorite measure — registering 2.4% in November compared with a year ago. This was lower than the consensus expectation of 2.5%, but was still an acceleration from 2.1% in September and 2.3% in October. The latest data-point should provide cold comfort to monetary policy makers who keep repeating that they are focused on achieving a 2% target.

After lowering the Federal Funds rate by a giant 50bp in September when the central bank was confident that inflation had been licked, the Chairman was forced to admit just three months later that the outlook for inflation and interest rates had become uncertain. Inflation was not conforming to the central bank forecast as it analyzed the outlook with rose-colored glasses!

What does 2025 hold for inflation and interest rates? With at least some of President-elect Donald Trump’s threats with respect to tariff increases and deportation of undocumented workers likely to be implemented within the first 100 days of the new administration, expect any price increase passed on to US consumers to be reflected in higher inflation rates during the first half of the year. This may prevent the FOMC from reducing rates even once during the year.

The base case is for no further reduction in interest rate during 2025, with the risk to investors being that the Federal Funds rate is actually raised.

Wishing readers all the best for the Holidays and a Happy New Year! This will be the last SriKonomics release of 2024. The next issue will come out on January 4, 2025.

Dr. Komal Sri-Kumar

President, Sri-Kumar Global Strategies, Inc.

Santa Monica, California

srikumar@srikumarglobal.com

@SriKGlobal

December 21, 2024

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