At its meeting on May 6-7, the FOMC chose to keep rates unchanged. They decided to leave the benchmark federal funds rate target range at 4.25% – 4.5%. This decision reflects the continued concern of the committee over the trajectory of fiscal and trade policy. These actions have injected toxicity and uncertainty into the American economic outlook.
Given all of these concerns, one could imagine FOMC officials considering an argument that holding rates constant was the safest direction to move in. Officials shaped the strategy that’s often called “flexible average inflation targeting.” This strategy would allow for inflation to temporarily exceed the 2% target. This strategy aims to facilitate broader, more equitable gains in the labor market. It is also highly constrained, especially in an environment more prone to inflationary shocks.
As the FOMC minutes showed, all participants recognized the heightened uncertainty around the economic outlook. They noted that this prompted a cautious approach as they await clearer insights into the effects of various government policy changes.
“Participants agreed that uncertainty about the economic outlook had increased further, making it appropriate to take a cautious approach until the net economic effects of the array of changes to government policies become clearer,” – FOMC minutes
The committee’s deliberations take place amid a backdrop of dynamic international trade relationships. Immediately after the FOMC meeting, the United States and China took an important step together. They agreed to suspend many of their most onerous tariffs while entering into a 90-day negotiation period. Bankers cheered as this unexpected development sparked a rally on Wall Street. It added a much-needed dose of hope to what was otherwise a grim, pessimistic landscape.
Beyond the tariffs, bond yields, too, have been on a parallel rise, enough for then Presidents Donald Trump to lament that yields are too high! The decade after the 2008 financial crisis had interest rates around zero, so today’s rates might seem elevated in that context. The FOMC’s last rate cut was in December. With robust economic growth and resilient labor market conditions, officials now appear poised to reconsider next steps for monetary policy.
“Participants noted that the Committee might face difficult tradeoffs if inflation proves to be more persistent while the outlooks for growth and employment weaken,” – FOMC minutes
We recognize how different the economic tide feels today. Participants highlighted that while economic growth remains robust, it is essential to consider how shifts in inflation could impact overall financial stability.
“In considering the outlook for monetary policy, participants agreed that with economic growth and the labor market still solid and current monetary policy moderately restrictive, the Committee was well positioned to wait for more clarity on the outlooks for inflation and economic activity,” – FOMC minutes
The Federal Reserve is sailing in difficult waters. Market participants and policymakers in Washington will be watching its decisions like a hawk. No doubt the interaction between international trade relations and domestic economic indicators will be key in determining how to recalibrate policy in the future.