The Federal Reserve (Fed) didn’t move policy rates at their May meeting, keeping them in the 4.25-4.50% range. This was widely expected, but all eyes (and ears) were on how they would telegraph future moves. Short answer: they didn’t. The only major change in the official post-meeting statement was that risks of higher unemployment and higher inflation have risen, but that raised a very obvious question.
Fed Chair Jerome Powell punted on the answer in several ways, mostly falling back on the refrain that they’re unable to see which way things will play out. He admitted that prioritizing one side of their mandate over the other will be a difficult judgement, but the good news is that they don’t have to decide now since the labor market looks healthy — so they can afford to wait and watch, without being in a hurry. Uncertainty has certainly increased, along with downside risks, but there’s nothing in the data yet. They still rate the economy as healthy, albeit with downbeat sentiment amongst consumers and businesses.
Focus Likely is Taming Inflation, at the Expense of Employment
If push comes to shove it looks like they’ll prioritize inflation. For one thing, Powell once again noted that “without price stability you cannot achieve long periods of labor market stability.”
Moreover, Powell added that policy is currently in a good place, which gives them a lot of flexibility to act down the road depending on how the data comes in. But by his own admission, policy right now is “sufficiently restrictive” despite the fact that the labor market is not a source of inflationary pressure.
Keep in mind that pausing on rate cuts is not a benign status quo — policy is implicitly getting tighter because wage growth is easing. Historically, the fed funds rate rising well above the pace of wages, i.e. increasingly tight monetary policy, has constricted the economy and ultimately these situations ended up in recessions.
In short, policy is tight right now and it’s going to remain tight until the Fed sees more data.
Powell also mentioned that eventually they may decide between their two mandates by focusing on the one that is further away from their goal.
Core inflation, as measured by their preferred personal consumption expenditures metric (PCE), is currently at 2.7% year over year (as of March). That is already elevated relative to the Fed’s target of 2%. But tariff front-running and higher import costs are likely to at least partially feed into consumer prices.
Expect the Fed to stay on pause for longer. And if they do cut, that’s not going to be good news, because it’ll mean the labor market has broken (and the Fed’s only going to be stepping in too late).
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