On Wednesday, the Federal reserve’s Federal Open Market Committee left the target federal funds rate unchanged at 4.25-4.5 percent. The FOMC statement on the current policy, released on Wednesday, reads (my emphases in bold):
Although swings in net exports have affected the data, recent indicators suggest that economic activity has continued to expand at a solid pace. The unemployment rate has stabilized at a low level in recent months, and labor market conditions remain solid. Inflation remains somewhat elevated.
The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. Uncertainty about the economic outlook has increased further. The Committee is attentive to the risks to both sides of its dual mandate and judges that the risks of higher unemployment and higher inflation have risen.
In support of its goals, the Committee decided to maintain the target range for the federal funds rate at 4-1/4 to 4-1/2 percent. In considering the extent and timing of additional adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks. The Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage‑backed securities. The Committee is strongly committed to supporting maximum employment and returning inflation to its 2 percent objective.
There are a few things we can learn from the wording of this report. The first, as indicated in the bold, is that the Fed is simply dismissing the first quarter GDP report which showed a fall of 0.3 percent in GDP for the period. There has been a lot of hand waving in regard to the weak GDP reading for the first quarter, with the GDP drop being blamed on an increase in imports.
Nonetheless, the FOMC statement also admits that “the risks of higher unemployment and higher inflation have risen.” This is significant coming from the Fed which always attempts to downplay economic news and opts for describing the economy in the best possible light. This is why, even in the wake of a negative GDP report, the Fed continues to claim that “economic activity has continued to expand at a solid pace.” This is just the usual cheerful Fed language we’ve come to expect. Remember that throughout its period of ultra-low interest rates during the Bernanke and Yellen years—when the truly weakened state of the economy was indicated by how the Fed was afraid to let the target interest rate rise to even 0.5 percent—the Fed routinely described economic activity as “solid” or expanding moderately.
If the Fed is now willing to say that the risk of stagflation is rising—which is what both higher unemployment and higher (price) inflation would mean—there is reason for concern.
With both price inflation and unemployment as rising risk factors, the FOMC is apparently just relying on hope that something will happen to change the situation, and this is likely why the FOMC chooses to take no action at all. It simply doesn’t know what to do.
We do find a hint as to the Fed’s true disposition on the economy, however, in its ongoing policy toward reducing its asset holdings. In its statement, the FOMC says “The Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage‑backed securities.“ This appears to be true, but note that the FOMC has repeatedly scaled back the rate at which it is reducing its hoard of mortgage-backed securities and Treasurys. This is essentially a dovish policy since a slowdown in the reduction of its asset holdings functions in a similar manner to pushing down interest rates.
Back in June 2024, the Fed reduced its cap on reducing its Treasury holdings from $60 billion per month to $25 billion per month. Then, it reduced the cap again in March down to a mere $5 billion per month. This suggests the FOMC is using its balance sheet reduction schedule as a means to further soften its monetary policy without having to actually change its target interest rate of 4.5 percent.
The Fed and the FOMC have good reason to not want to make any sudden moves that might pop the many easy-money fueled bubbles currently propping up the US economic data. For one, the Dallas Fed’s manufacturing index reported plenty of bad new in April, noting:
The new orders index plummeted 20 points to -20.0. The capacity utilization index edged down to -3.8, and the shipments index fell into negative territory for the first time this year, slipping to -5.5 from 6.1. … Perceptions of broader business conditions continued to worsen notably in April. The general business activity index fell 20 points to -35.8, its lowest reading since May 2020. The company outlook index also retreated to a postpandemic low of -28.3. The outlook uncertainty index pushed up 11 points to 47.1.
With business outlooks falling to “pre-pandemic lows” it’s unclear just how “solid” the economic growth continues to be.
Moreover, even the Fed’s own April Beige Book makes a very unusual admission, noting in its summary that “there were scattered reports of firms preparing for layoffs.” The summary concluded that five of the Fed’s twelve districts experienced economic contraction or slowing, while another three were flat. Only four of the twelve districts showed growth at all, and the growth was reported as “slight” in all those cases. Mysteriously, the FOMC nonetheless describes current economic activity as “solid” growth.
As usual (since 2011) the Fed chairman took questions at a press conference following the release of the FOMC statement, and the big takeaway from Chairman Powell’s responses was that the Fed simply has no idea what is going to happen next, or what the Fed is going to do next.
(Many of the reporters in the room wasted everyone’s time with dumb questions asking Powell about how Trump’s comments on Powell’s potential reappointment affected Powell’s feelings. Powell declined to answer these questions.)
When asked about the overall state of the economy, Powell continually reiterated that “uncertainly is extremely elevated and the downside risks have increased.” When a reporter noted the negative leaning of the Beige Book, Powell responded that the data in the report “may well point to a slowdown, but it hasn’t shown up yet.”
The notion that the data increasingly points to recession, but that recession has not yet materialized, was a repeated theme as well. Another reporter noted that the so-called “soft data”—i.e., the survey data on sentiment—is increasingly negative. The reporter asked at what point this soft data would affect the Fed’s decision making. Powell, as with so many questions, stated the Fed and the FOMC are simply waiting for more information.
Lest there be any continued confusion about the alleged exalted abilities of Fed economists to accurately forecast economic conditions, let it be noted that the Fed simply has no idea what comes next, or what to do about it.
We can hazard a guess as to what step comes next, however. The Fed has now held the target federal funds rate at 4.5 percent for six months, and this comes after reducing the target rate by 100 basis points from September 2024 to December 2024.
In recent decades, the Fed has never returned to a period of rising rates after so long a period of pushing the target rate back down. So, at this point, the odds of the Fed allowing interest rates to rise is virtually zero. We can be nearly certain that the next move by the Fed will be to further push down the target rate. At this point the question is only “when” and “by how much.”
Indeed, were there not ongoing concerns about reigniting price inflation, we could be sure that the Fed would have already cut the target rate at least once over the past three months. In spite of Powell’s assurance, however, there is no sign of price inflation returning to the Fed’s arbitrary two-percent target. PCE inflation is now actually slightly higher than it was in September when the Fed cut the target rate and explained that it was sure price inflation would soon return to its two-percent target. That has clearly not happened as the Fed has hoped, and the Fed is now hemmed in by a rising risk of stagflation.
