Federal Reserve policymakers were in near-unanimous agreement to keep interest rates on hold at their meeting last month, but remained split over their next steps, with “several” open to rate hikes if inflation remains elevated, others inclined to support further cuts if inflation recedes as they expect, and the full table grappling with the emerging implications of artificial intelligence for the economy.
The split evident in the readout from Fed Chair Jerome Powell’s third-to-last meeting as head of the U.S. central bank underscores the challenge ahead for former Fed Governor Kevin Warsh, President Donald Trump’s pick to take over from Powell in May, in convincing the policymaking group to support the rate cuts Warsh and Trump say are needed.
The Federal Open Market Committee’s decision last month to hold its benchmark interest rate in the 3.50%-3.75% range was shared by “almost all” of its policymakers, according to the January 27-28 meeting minutes released on Wednesday. But the opinions expressed from there included a dose of AI-optimism about a coming productivity boom and resulting drop in inflation, and a mirror-image concern that AI investment was posing financial risks based on rising asset valuations and the involvement of “opaque private markets.”
“Several participants … expected higher productivity growth associated with technological or regulatory developments to put downward pressure on overall inflation,” the minutes noted. “Most participants, however, cautioned that progress toward the Committee’s 2% objective might be slower and more uneven than generally expected and judged that the risk of inflation running persistently above the Committee’s objective was meaningful.”
AI brings great potential, risk and uncertainty
The debate at the January meeting reflected a potentially challenging time ahead for Powell and then Warsh, as policymakers grapple with the flow of short-term economic data while trying to divine how, and how rapidly, the potentially profound, AI-driven restructuring of the economy plays out.
The Fed staff’s analysis, for example, anticipates strong growth to continue, an outlook consistent with what the Trump administration says its policies will accomplish. But the staff feels that growth will “outpace potential,” and they penciled in higher inflation, “reflecting the expectation that resource utilization would be tighter.” That runs counter to the idea, already endorsed by Warsh, that productivity gains will unfold fast enough to support stronger growth with less pressure on prices.
With AI seen as a source of great potential, risk, and uncertainty, the Fed’s decision last month to pause its monetary easing seemed appropriate to assess where the economy stood after 75 basis points of rate cuts last year, the minutes said.
Only a “couple” of policymakers supported another move at the meeting. Fed Governors Christopher Waller and Stephen Miran both cast dissenting votes in favor of a rate cut based on concerns the job market may be at risk of weakening.
Beyond that, opinion fractured among the other 17 officials. The minutes, for example, included the first recent mention of possible rate hikes if inflation remains above the Fed’s 2% target. It is currently running about a percentage point above that level.
Though an expected easing of inflation this year is widely anticipated and expected to clear the way for further rate cuts, the minutes said that “several participants indicated they could have supported a two-sided description of the Committee’s future interest rate decisions, reflecting the possibility that upward adjustments to the target range for the federal funds rate could be appropriate if inflation remains at above-target levels.”
“Some” others felt rates would need to be on hold “for some time” while they awaited new inflation and economic data, with a subset of that group arguing that cuts may not be appropriate at all until there is evidence that “disinflation is back on track.”
“Several” officials, by contrast, said their baseline outlook for inflation and the economy included further rate reductions.
“Policymakers are going in opposite directions with inflation still above the Fed’s target. They can’t even agree on whether the current rates are restrictive or neutral. The next chairman could have a tough job building consensus,” said David Russell, global head of market strategy at TradeStation.
Fed leadership succession
The minutes put the debate at the January meeting in a hawkish light as officials voted to hold the policy rate steady in the current range and signal it may remain there for some period of time.
Following the release of the minutes, investors stuck to bets that the Fed will keep its policy rate on hold until the June 16-17 meeting, which is expected to be Warsh’s first, with quarter-percentage-point rate cuts anticipated at that session and the one in September.
Market pricing does not reflect any chance of a rate hike in the foreseeable future.
The June meeting could be Warsh’s first as Fed chief if he is confirmed by the U.S. Senate in time to take over when Powell’s term as head of the central bank ends.
The Fed’s next meeting is scheduled for March 17-18, when policymakers will provide updated economic and interest rate projections.
Data releases since the January meeting have done little to resolve the debate over whether the Fed should prioritize putting further downward pressure on inflation by leaving borrowing costs where they are or supporting job and economic growth with cheaper credit.
Consumer price inflation for January was weaker than expected, yet job growth for the month beat expectations and the unemployment rate fell, with most officials saying they expect reasonably strong economic growth to continue.
(Reporting by Howard Schneider; Additional reporting by Ann Saphir; Editing by Andrea Ricci and Paul Simao)
