After raising rates in 2022 to belatedly combat inflation, the FOMC was feeling successful in 2024. They were holding the line and remaining steadfast while many people were getting all in a tizzy about pushing us into a recession. People had been predicting a recession since 2022, and the Fed kept the federal funds rate steady at 5.33% for an entire year. Repeatedly, in the first half of 2024, betting markets were upset that the Fed wasn’t budging. I had friends saying that the time to cut was in 2023 once they saw that Silicon Valley Bank failed. I remained sanguine that rates should not be cut.
I thought that rates should have been higher still given that the labor market was strong. But, I also didn’t think that was going to happen. My forecasts were that the Fed would continue to keep rates unchanged. At 5.33%, inflation would slowly fall and there was plenty of wiggle room for unemployment.
Then, we had a few months of lower inflation. It even went slightly negative in June 2024. Some people were starting to talk about overshooting and the impending recession. I documented my position in August of 2024. Two weeks later, Jerome Powell gave a victory lap of a speech. He said that “The time has come for policy to adjust”. Instead of discerning whether the FOMC would cut rates, the betting markets switched to specifying whether the cut would be 0.25% or 0.5%. The Fed chose the latter, followed by two more cuts by the end of the year.
I was wrong about the Fed’s policy response function. But why? Was the FOMC worried about the downward employment revisions? That was big news. Did they think that they had inflation whipped? I’m not sure. There was a lot of buzz about having stuck the soft landing. In late 2024, I leaned toward the theory that the Fed was concerned about employment. Like, they thought that we had been doing better until then.
Now here we are in February of 2025. My current perspective is that maybe the FOMC was enjoying the good press and left the punch bowl out (I also thought so in September, but I didn’t write it down…). The most recent CPI numbers are too high. Those numbers might get revised down. We’ll see what the more accurate PCE numbers are later this month, but there’s some reason for worry. With three months of CPI above 3% and January’s numbers coming in at 5.7%, the moving average is only rising. Granted, February is a new month and this might be a blip and the PCE is more dependable.
What about the employment picture? Unemployment is now back down to 4% from 4.2%. And Employment growth shot up in December. Maybe that’s a Trump bump. Most published opinions seemed to think that rates would keep falling and that may account for greater hiring.
I was wrong about the Fed policy response function. But I take tentative solace that I don’t think that I was wrong about what they “should” do. I think that their cuts were a mistake and communicated that they aren’t super serious about inflation. The whole ‘medium run’ emphasis that they were touting two years ago isn’t consistent with the late rate cuts of 2024, IMO. The news is now saying that we can forget another rate cut this year. That seems extreme, but I do think that we shouldn’t expect one before the summer.
Furthermore, regardless of who won the election, the Federal government doesn’t have its fiscal act together. Substantial and worsening deficits will require a steady or higher fed funds rate rather than cuts. This hasn’t always been my opinion. My preference is that the congress spends less. But I also have a track record of being soft on the economic importance of the US federal debt.
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