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The Federal Reserve has signaled a significant shift in its monetary policy approach, marking a new phase in its efforts to balance economic growth and inflation control. In a recent press conference, Federal Reserve Chair Jerome Powell outlined the central bank’s decision to lower interest rates and its cautious stance on future policy adjustments.
Key Policy Changes
The Federal Open Market Committee (FOMC) has taken two crucial steps:
- Reduced the policy interest rate by 0.25 percentage points
- Decided to continue reducing securities holdings
- The number of projected rate cuts for next year has been reduced from 4 to 2 and 1 Cut in 2026
- The long-run federal funds rate expectation has increased to 3%.
- Dissent: Cleveland Fed President Beth Hammock preferred to leave rates unchanged.
- Committee Views:
- 10 members see 2 cuts next year
- 5 members see 3 or more cuts
- 3 members forecast 1 cut
- 1 member suggests leaving rates unchanged through 2025 and 2026
These actions reflect the Fed’s assessment that the economy is strong overall and has made significant progress towards its dual mandate goals of maximum employment and price stability. The 10 Year Yield did not like the news.
Economic Forecasts
- Inflation: Both PCE headline and core inflation forecasts have been revised upward.
- Headline inflation: 2.5% by end of next year (up from 2.1%)
- Core inflation: 2.5% by end of next year (up from 2.2%)
- Unemployment: Expected to be 4.3% at the end of next year.
- GDP Growth:
- 2024 end: 2.5% (up 0.5% from September forecast)
- 2026: 2.1% (indicating a significant slowdown)
Powell highlighted several positive economic indicators:
- GDP growth remains solid, with an annual rate of 2.8% in the third quarter
- Consumer spending remains resilient
- Investment in equipment and intangible assets has strengthened
However, the housing sector continues to show weakness. The labor market conditions remain solid, with the unemployment rate at 4.2% in November, considered low by historical standards.
Inflation Progress and Challenges
Inflation has eased significantly over the past two years but remains somewhat elevated relative to the Fed’s 2% longer-run goal. The latest estimates indicate:
- Total PCE prices rose 2.5% over the 12 months ending in November
- Core PCE prices (excluding food and energy) rose 2.8% over the same period
The Fed expects inflation to continue declining, with projections showing total PCE inflation at 2.4% this year and 2.5% next year, before falling to the 2% objective.
New Phase in Monetary Policy
Powell emphasized that the Fed is entering a new phase in its policy approach:
- The policy rate has been reduced by a full percentage point from its peak
- The current policy stance is significantly less restrictive
- Future adjustments will be made more cautiously
The Fed will assess incoming data, the evolving outlook, and the balance of risks when considering further adjustments to the target range for the federal funds rate.
Future Policy Direction
- The Fed will be more cautious about further rate adjustments.
- Further cuts will depend on continued progress on inflation and labor market strength.
- The committee does not see a need for additional labor market softening to achieve 2% inflation.
Market Implications and Economic Outlook
Financial markets have responded positively to the Fed’s actions throughout the year. However, Powell noted that while financial conditions are important, the Fed focuses primarily on how its policies affect the broader economy and its goal variables.
The Fed remains optimistic about the U.S. economy’s performance, especially compared to its global peers. Powell expressed confidence in avoiding a recession, with GDP growth projected to remain solid at around 2% over the next few years.
Summary of speech
The Federal Reserve announced a significant change in its monetary policy stance on Wednesday, cutting interest rates by 25 basis points and signaling a more cautious approach to future rate adjustments. This marks the Fed’s first rate cut since March 2020 and brings the federal funds rate to a range of 4.25-4.5%.
In his press conference, Fed Chair Jerome Powell emphasized that the U.S. economy remains strong, with GDP growth projected at about 2% over the next few years[1]. However, the Fed now sees fewer rate cuts in 2025 than previously anticipated, with the median projection showing only two cuts next year instead of four.
Powell noted that inflation has eased significantly but remains above the Fed’s 2% target. Core PCE inflation is estimated at 2.8% through November, down from a high of 5.6%. The Fed expects inflation to reach 2.5% by the end of next year, higher than previously projected.
The labor market remains solid, with unemployment at 4.2% in November. Powell stated that the Fed does not believe further cooling in the labor market is necessary to achieve 2% inflation.
Looking ahead, Powell indicated that the Fed will be more cautious about further rate adjustments. He emphasized that future cuts will depend on continued progress on inflation and labor market strength. The Fed sees risks to achieving its employment and inflation goals as roughly balanced.
This shift in policy stance reflects the Fed’s confidence in the economy’s strength while acknowledging the need for continued vigilance on inflation. As Powell stated, “We’re committed to maintaining our economy’s strength by supporting maximum employment and returning inflation to our 2% goal”.
Conclusion
As the Federal Reserve navigates this new phase of monetary policy, it remains committed to supporting maximum employment and returning inflation to its 2% goal. While challenges persist, the overall economic outlook appears positive, with the Fed prepared to adjust its approach as needed to maintain economic stability and growth.