Markets and observers weren’t surprised when the Federal Reserve held its policy rate steady at the April meeting. More notable, in our view, were the three dissents by voting participants who did not support keeping the implicit easing bias in the policy statement’s forward guidance language. We presume their preference would have been a stronger signal that the next interest rate move, whenever it occurs, could be either a hike or a cut.
Our view remains that the next move will be a rate cut, but the timing is far from clear.
Chair Jerome Powell’s press conference emphasized the wide range of possible outcomes associated with the Middle East conflict, along with generally high uncertainty. He suggested that changes to the statement were a close call – more committee members supported more hawkish changes than during the previous meeting in March. Powell also argued that Fed policy is in a good place to react to the economic implications of the energy supply shock, which poses risks to both sides of the Fed’s dual mandate: maximum employment and price stability.
Markets thus far seem to have interpreted the Fed’s signals as a hawkish shift, though the reaction seems tempered by expectations that Kevin Warsh, the incoming Fed chair, will be able to keep the Fed on hold despite stagflationary pressures from the Middle East conflict.
We still think there is a high bar for the Fed to reverse course and hike rates. Given the significant uncertainty over energy prices and energy supply (for details, read Macro Signposts, “Temporary Disruption – or the Start of a Global Supply Shock?”), the Fed is likely to hold rates steady until it sees the inflation/unemployment trade-off becoming clearer.
Why the tone skewed a bit more hawkish
With the Fed widely expected to be on hold, the meeting was always going to be about communications. The statement kept its implicit easing bias – which garnered the three dissents – while Governor Stephen Miran continued his pattern of dissenting in favor of easier policy.
The easing bias in the statement is subtle and centers around the forward guidance sentence: “In considering the extent and timing of additional adjustments to the target range for the federal funds rate …” The word “additional” in this context has been interpreted to mean additional cuts. The dissenters would have presumably preferred to more strongly suggest that the next rate move could be either a cut or a hike – we see a hawkish (or at least less dovish) leaning implied in their dissents. That forward guidance language could be changed or removed as soon as the next meeting, if developments warrant it.
At the press conference, Powell articulated a modest shift in Fed views in a more hawkish direction. In practice, this likely translates to a period of holding rates steady until the economic data, outlook, and balance of risks paint a clearer picture for the policy path.
Baseline still implies cuts, but timing looks more conditional
Despite all of this, we still expect the next rate move will eventually be a cut, and we still pinpoint roughly 3% as the neutral policy rate. However, the timing is uncertain. If the Iran conflict and energy shock appear more persistent, it could take longer for core inflation to more clearly begin to moderate back toward the Fed’s target, complicating the decision to ease monetary policy.
Many observers and policymakers remember the pain of the sharp inflation spike in 2021–2022. We see important differences between now and then that should help mitigate core goods price inflation spillovers into broader services categories. The widespread inflation during the post-pandemic episode was also related to large fiscal transfers (such as federal spending packages to support households and businesses) and compounded by an extremely tight labor market – factors that aren’t present today.
Eventually, as energy prices moderate (assuming they do), the Fed could still cut a few more times to align the current policy range of 3.5%–3.75% with the Fed’s median estimate for neutral policy of roughly 3%.
On the other hand, in a risk scenario where there is a more prolonged disruption in physical energy supplies out of the Middle East, the trade-offs look starker. Even though the U.S. is relatively insulated as a net energy exporter, the higher global recession risks, and likely tightening financial conditions, would eventually lead to rate cuts, in our view – although an initial surge in global inflation would likely delay the central bank’s reaction to weaker activity.
Warsh transition unlikely to shift policy outlook
This was likely Jerome Powell’s final meeting as Fed chair. He committed to staying on as a governor until the legal investigations into him and the Fed building renovation costs were over with “transparency and finality.” He also said that Fed officials should be able to “make monetary policy without political considerations.” He did commit to stepping down, but his comments leave plenty of room for interpretation on when he might feel comfortable with leaving. He also committed to maintaining a “low profile” as a governor and to aiding soon-to-be Chair Warsh where he can.
Powell also shared that Fed officials are worried about a continuation of challenges against the Fed or its people, and he specifically noted that the removal of Federal Reserve Bank presidents due to policy choices would be “the beginning of the end.”
In our view, the Warsh transition should mainly affect Fed communication – and market interpretation – rather than interest rates themselves. Warsh did not seem overtly dovish in his Senate hearing. Indeed, he criticized the Fed for being late to act on inflation in 2022. He did point to trimmed mean and median inflation measures, which are currently running under core personal consumption expenditures (PCE) inflation – a modestly dovish lean. These measures have historically tended to run above core inflation and will likely accelerate if higher energy prices broadly push core goods inflation higher.
Our working assumption remains that Warsh’s current bias (similar to the Fed’s median) is toward cuts, and that the Fed will remain an independent institution under his watch.
