Fed Underscores Uncertainty but Doesn’t Lower Rates

Comments from Jeff Klingelhofer, CFA, a managing director and portfolio manager for Aristotle Pacific Capital

Here are my four main takeaways from May's FOMC meeting, along with four inferences that I believe can be made by the Fed’s actions.

Takeaways

• ‍Heightened uncertainty underscored: In its new policy statement, the Fed raised more alarm bells about the economy, inflation, and employment rates by adding “further” to this sentence: “Uncertainty about the economic outlook has increased further.” Another added warning stated, “[T]he risks of higher unemployment and higher inflation have risen” since the prior meeting.
• Lack of concern about recent economic data: To me, this was the biggest surprise of the meeting. I thought the Fed mostly dismissed near-term economic data weakness, and the first-quarter negative GDP print. In fact, the Fed led its revised policy statement with, “Although swings in net exports have affected the data, recent indicators suggest that economic activity has continued to expand at a solid pace.”
• No declaration of independence: I had hoped for the Fed to rise to the occasion and preach the virtues of the independence of the central bank. Instead, Chair Jerome Powell repeatedly shut down the question at the post-meeting press conference and gave only one small jab at Congress, but not President Trump. I had expected Chair Powell to defend the independence of the Fed for the benefit of the people it serves. In my view, this was a disappointment, and I hope the Fed will come out with a stronger stance soon.
  
• Little forward-looking guidance: Though asked many times during the press conference, Chair Powell refused to provide any other forward-looking guidance than to suggest heightened uncertainty and to provide assurance that the Fed had the ability to act in a timely manner, if needed. Chair Powell went as far as to say, “We are in a good place to wait and see.”

What Went Unsaid

Here’s what I believe can be implied from the outcome of the FOMC meeting.

• Any substantive move in the fed funds rate is likely to be a cut. However, I suspect it will come only after unemployment has risen significantly, and it likely won’t come until it is too late to avoid an economic turndown. In the meantime, I think we may get a token cut or two, but there will be no major moves until the direction of travel is clear and unstoppable.
• The ongoing tension in the Fed’s dual mandate between potentially rising inflation and higher unemployment is overblown. The Fed believes increased prices generated by tariffs are likely to be transitory and will act as a tax rather than a sustained rise in inflation. Because of this, I believe the Fed is likely to cut in response to rising employment, while tolerating transitory inflation.
• If the Fed does have to choose between lowering inflation or seeking maximum employment, it’s not a contest. The Fed has been exceptionally clear about the priority of their mandate: price stability. It has repeatedly argued that price stability is a pre-condition for sustained high employment.

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