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January 27, 2025

The Federal Open Market Committee (FOMC), the policy setting arm of the Federal Reserve, is expected to keep a low profile as it moves into wait-and-see mode. The Fed will not front run policy shifts by the new administration. Instead, it will wait for policy shifts to occur and see how they play out before reacting to them. That doesn’t mean potential policy shifts do not creep into the forecasts of what FOMC members think they will need to do with rates going forward.

The pause in January has been well telegraphed. One participant at the December meeting, Cleveland Fed President Beth Hammack, dissented on the rate cut. That rarely occurs in a vacuum. Minutes to the meeting subsequently revealed that she had company.

Participants at the December meeting uniformly scaled back their estimates of interest rate cuts for 2025. That reflected a combination of robust growth as well as concern that the path down for inflation will be longer than the path up, amid the threat of tariffs. 

Another reason for caution in January is a shift in those who will vote on policy. Four regional Fed presidents rotate into voting roles on the FOMC in January.  Three are known inflation hawks. They include the Presidents of the Kansas City, St. Louis and Boston regional Feds. There is one dove, the Chicago Fed president, who favors more rate cuts but is comfortable spacing them out. 

The Fed’s favored inflation gauge, the personal consumer expenditure (PCE) index, is expected to show a little more service sector inflation than we saw in the CPI in December. The measure of airfares that feeds into that index spiked in December, at the fastest pace on record.

We are poised to see an improvement in inflation at the start of the year. A surge in inflation at the start of 2024 makes for easier year-on-year comparisons, while the seasonal factors for the PCE index have artificially boosted measures of inflation. The next Fed cut is expected in March, barring a major policy shift before then. 

The wildcard is fires in Los Angeles and how they distort prices. There were reports of price gouging, especially on rents as people tried to find places to stay after losing their homes. Los Angeles was already suffering from an acute housing shortage prior to the fires. Costs for cleanup and repairs could further stress materials costs in the months to come. 

Separately, the employment report for January is likely to be suppressed by the job losses triggered by the fires. Fires were still burning during the week of the survey. We saw unemployment claims surge in the wake of hurricanes last Fall.  

The last executive order signed on January 20 was a memorandum, which greased the wheels for future tariffs. The order directed economists within the US Department of Treasury, the US Trade Representative (USTR)’s Office and the Commerce Department to look at goods, currencies and free trade agreements in areas ripe for tariffs, export controls and outbound investment controls. 

The goal is to get recommendations regarding tariffs and other curbs on trade to the President by April 1. These types of investigations usually take years. There is traditionally a comment period, which is controlled by the USTR, when firms can ask for waivers. It is unclear whether that would occur this time around. 

As noted above, much is still uncertain about tariffs. The Fed is clearly worried that they could be more inflationary this time around than in 2018. The embers of the pandemic inflation are still burning, while supply chains are longer and more vulnerable to retaliation than they were prior to the pandemic. Context matters. 

The Fed would prefer to stop short on rate cuts than reverse course and have to raise rates if inflation were to reignite. It still has hopes of achieving a soft landing. A 180 degree turn in policy would up the risk of a higher unemployment rate.