Fed Talk 6.18.25 – CAPATA Financial’s Take on FOMC Press Conference

Notable comments from Chairman Powell during today’s FOMC press conference and announcement.

From the FOMC statement:

• “Although swings in net exports have affected the data, recent indicators suggest that economic activity has continued to expand at a solid pace…Uncertainty about the economic outlook has diminished but remains elevate.”:  The Fed had previously indicated that net export data would be highly volatile, as companies stockpiled inventory in March to get ahead of tariffs. The uncertainty in the economy reflects a shift from the highest tariff levels announced in early April to the current reduction and pause in tariff policy.  In the Summary of Economic Projections (SEP), the committee raised its forecast for inflation from 2.7% in March to 3.0%, and for unemployment from 4.4% to 4.5%. This aligns with the reduced projection of only two rate cuts in 2025.

From the FOMC press conference

• “The effects of tariffs will depend, among other things, on their ultimate level.  Expectations of that level, and thus of the related economic effects, reached a peak in April and have since declined.  Even so, increases in tariffs this year are likely to push up prices and weigh on economic activity.”:  Powell’s prepared statement emphasized that the Fed’s base case is that tariff, though likely to be less severe than originally announced, will slow the economy and increase prices.  This realization is evident across the board in the Summary of Economic Projections (SEP), with FOMC members marking down GDP forecasts for this year to 1.4% and revising inflation forecasts upward.

• “Our obligation is to keep longer-term inflation expectations well anchored and to prevent a one-time increase in the price level from becoming an ongoing inflation problem.”:  In his opening statement—which he reiterated in response to the first reporter’s question—Chair Powell emphasized the ongoing theme that inflation expectations are key to preventing a one-time increase in prices from triggering a prolonged inflationary period.  He recognizes that unanchored expectations, as seen during the 1970s, can become a self-fulfilling prophecy. 

• “…we have to be forward-looking, and the thing that every forecaster, every outside forecaster, and the Fed is saying, is that we expect a meaningful amount of inflation to arrive in the coming months…a backward-looking look would lead you to a neutral stance.”:  Powell, in no uncertain terms, stated that the Fed does expect inflation to rise.  With the economy currently in a strong position—unemployment at a low 4.2%, inflation near the 2% target, and positive GDP growth—the Fed can afford to take a wait-and-see approach, gathering more data to make better-informed decisions.  Because the Fed must be forward-looking, it needs to anticipate the price pressures expected from rising inflation.  As a result, it is holding off on reducing rates to a more neutral level, despite signs of economic slowing.  “What we are waiting for to reduce rates is to understand what will happen with the tariff inflation.”

• “The U.S. economy defied all kinds of forecasts for it to weaken over the last three years and it’s been remarkable to see, again and again, when people think its going to weaken; eventually it will but we don’t see signs of that now.”:  Milton Friedman famously noted that monetary policy operates with “long and variable lags.”  Forecasts predicting a weakening economy were repeated frequently as the yield curve inverted throughout 2022 and into 2023—with the 1-year/10-year Treasury spread at times more than 200 basis points inverted.  However, in today’s ample reserve regime—where the federal funds rate is managed through administered rates like the Interest on Reserves (IOR/IOER) and the Overnight Reverse Repo Program (ON RRP) for non-banks—the Fed has injected billions into the banking system in the form of interest payments on reserves (currently around $3.2 trillion).  This elevated short-term rate environment has channeled funds into the banking system, creating a supportive backdrop for banks not seen prior to the financial crisis.  Unlike the pre-financial crisis era’s scarce reserve framework, the current regime has acted as a tailwind, especially when paired with relatively low 10-year Treasury yields (~3%) through 2023 and early 2024.  If longer-term rates remain low and banks continue earning higher interest on reserves, the resulting conditions are stimulative.  As a result, the traditional signal of an inverted yield curve has diminished predictive power in an ample reserve environment.

In summary, Powell emphasized that the economy is currently in a solid position, with low unemployment (4.2%), encouraging inflation readings over the past three months, and 12-month PCE inflation at 2.3% as of May. While GDP growth remains positive, it is expected to slow. Taken together, these factors support the Fed’s wait-and-see approach, allowing more time to assess the ultimate size and impact of the tariffs on inflation and the broader economy.

Because Powell’s base case is that inflation will rise in the coming months, the policy rate is set to remain modestly restrictive.  Cutting rates now, only to later respond to accelerating inflation, risks a repeat of the 2022 scenario, when the Fed was forced to tighten policy rapidly and aggressively—potentially (at the time) causing more damage than a forward-looking, preemptive approach involving gradual rate adjustments.  It is important to remember that monetary policy is a blunt instrument that operates primarily through the demand side of the economy and with long and variable lags. The Fed is erring on the side of caution, as it sees inflation diverging from its target more imminently than employment.

While politically more difficult, the simpler part of the Fed’s job is using policy to tame inflation.  In contrast, the more challenging task is consolidating the victory over inflation once it has subsided.  Powell appears to be attempting to accomplish both Volcker’s mission of bringing inflation down and Greenspan’s mission of consolidating his victory—all within a single term.  This is an extraordinarily difficult task, especially in an environment of ongoing tariff and policy uncertainty.