Toward, not to, 2%

Santa Claus disguised as the Federal Reserve Chair made an early appearance last week. Not usually thought of as one to bring cheer, Jerome Powell surprised markets with a dovish view of Fed rate-setting policy.

In his press conference after the FOMC meeting, Powell dodged his chance to refute the growing rate cut bullishness in the markets by saying that people have different forecasts about the economy. Instead, he sounded confident that the inflation battle had been won and that federal funds rate cuts would be the next act. Powell’s comments moderated the Fed’s previous inflation target from a hard 2% target to a softer one of making progress toward 2%. He explained that waiting until it hit 2% before cutting could cause the Fed to overshoot, as monetary policy tends to work with a lag. By that same logic, easing rates before a recession hits could help avert the slowdown. Investor reaction was exceedingly positive. The Dow Jones Industrial Average soared to an all-time high and Treasury yields plummeted. 

In the Fed’s new quarterly Summary of Economic Projections, it forecast three 0.25% rate cuts next year, up from two in its September dot plot. It sees the unemployment rate rising only from 3.8% to 4.1%, the same as its new longer-run median value. Officials project Inflation will not fall to 2.0% until 2026. That translates to a decline from current inflation to their 2.4% year-end 2024 projection. That would be consistent with the progress to 2% and incorporate rate cuts. Because Powell did not challenge market assumptions, they have priced in nearly six quarter-point cuts in 2024, continuing the disconnect between the Fed and markets. 

Can this string of good fortune continue? Powell stopped short of taking a victory lap, but implied that the Fed is quite happy with how this year has played out. In a year of surprises, the Fed’s abrupt shift to trying to avert a recession saved the best for last.