Quick View – The Fed’s unanswered question: Just a skip, or a pause?

Originally Posted, 29 Jan 2025 – Quick View – The Fed’s unanswered question: Just a skip, or a pause?

Daniel Siluk – Head of Global Short Duration & Liquidity | Portfolio Manager

Head of Global Short Duration Dan Siluk explains that a convergence of stalled progress on inflation and uncertainty surrounding the policy priorities of the Trump administration has caused the Federal Reserve (Fed) to prioritize the price stability component of its dual mandate.

While the Federal Reserve’s (Fed) first Open Market Committee (FOMC) meeting of 2025 was expected to deliver few fireworks as investors anticipated status quo on rates, the accompanying statement and Chairman Jerome Powell’s comments offered much to ponder in terms of future monetary policy direction amid an evolving economic backdrop and noteworthy political developments.

We interpret the Fed’s statement as a continuation of the hawkish shift that occurred at its December meeting. Reinforcing this was the removal of the reference to “progress on inflation” found in the Fed’s previous statement. That alone causes us to question whether the Fed decision’s to not lower its policy rate for the first time in four meetings is a skip – meaning cuts will eventually resume – or a pause – a scenario that leaves the door open that this easing cycle may have reached its conclusion. A pause should not be interpreted as rate hikes being imminent, especially as the current level can still be viewed as restrictive.

A bias in the dual mandate

While some underlying data such as job openings and quits have indicated patches of labor market softness, the headline payrolls data and unemployment rate have stabilized – at a still low level – in recent months. Yet with economic resilience comes the risk of inflation finding a second leg.

Data bear this out, as the headline personal consumption expenditure (PCE) price index has risen from 2.1% to 2.4%, and the Fed’s favored gauge that excludes volatile food and energy climbed from 2.6% to 2.8% between June and November. In this respect, a steady labor market could give the Fed cover to maintain its December shift toward focusing on inflation.

An eye toward Pennsylvania Avenue

Chairman Powell framed the Fed’s current stance as “well positioned” to respond to future economic developments. A more apt description is they are in limbo. And rather than simply observing how the labor market and prices continue to adjust to the earlier 100 basis points (bps) worth of cuts, the central bank has little choice but to factor in the potential ramifications of the Trump administration’s economic agenda. While Mr. Powell was tactful in stating that the Fed must incorporate potential policy shifts for every incoming administration, the breadth that President Trump’s agenda – if taken at face value – could impact the economy cannot be understated. Areas that bear monitoring are tariffs, fiscal policy, immigration, and regulation.

Pricing in uncertainty

While broader markets would welcome the pro-growth components of the administration’s economic platform, the decidedly inflationary aspects – with potentially little economic upside – would only inject additional volatility into the outlook for rates and fixed income markets. The markets, it must be noted, have already reacted, as a potential Trump victory was behind the late-year selloff in Treasuries, despite the consensus expectation for the commencement of a rate-cutting cycle.

Looking forward, while the Fed’s rhetoric may emphasize its dependence on data and separation from fiscal policy, it recognizes – especially after the pandemic-era fiscal blowout – that it does not operate within a vacuum and that government actions (or overreactions) can greatly influence its policy trajectory.

We expect a certain amount of rate volatility until the details of President Trump’s policies are further articulated. Already, forward-looking markets have backed off the number of rate cuts they expect for 2025, with the current expected tally being two 25 bps cuts. We consider the policy rate at 4.5% already restrictive given a core PCE of 2.8%. Maintaining the status quo can either be viewed as a vote of confidence that the pro-growth aspects of the Trump administration’s policy will extend the economic cycle by maintaining – or raising – real growth rates, or the Fed believes the more inflationary aspects merit continued restrictiveness.

Holding pattern

Given the expected volatility and the uncertainties surrounding trade policies and the economic agenda of the Trump administration, opportunities will likely emerge for nimble investors. The key will be to closely monitor developments, both in terms of economic data and policy announcements, to navigate the potentially choppy waters of 2025 effectively.

Investors should pay especially close attention to the Fed’s March announcement, as it will provide an updated Summary of Economic Projections, providing greater visibility into the Trump administration’s economic agenda.

Although the U.S. Treasuries curve is no longer inverted, sputtering progress on inflation and policy uncertainty lead us to believe that it’s not the time to add duration. Instead, we think the front end of the curve is a prudent place to concentrate portfolios until the economic and policy directions become clearer.

Definitions

Basis point (bp) equals 1/100 of a percentage point. 1 bp = 0.01%, 100 bps = 1%.

Core Personal Consumption Expenditure Price Index is a measure of prices that people living in the United States pay for goods and services, excluding food and energy.

Duration measures a bond price’s sensitivity to changes in interest rates. The longer a bond’s duration, the higher its sensitivity to changes in interest rates and vice versa.

The Federal Open Market Committee (FOMC) is the body of the Federal Reserve System that sets national monetary policy.

Fiscal policy: Describes government policy relating to setting tax rates and spending levels. Fiscal policy is separate from monetary policy, which is typically set by a central bank.

Monetary policy: The policies of a central bank, aimed at influencing the level of inflation and growth in an economy. Monetary policy tools include setting interest rates and controlling the supply of money. Dovish policy aims to stimulate economic growth by lowering interest rates and increasing the money supply. Hawkish policy aims to curb inflation and slow down growth in the economy by raising interest rates and reducing the supply of money.

Quantitative Easing (QE) is a government monetary policy occasionally used to increase the money supply by buying government securities or other securities from the market.

Volatility measures risk using the dispersion of returns for a given investment.

A yield curve plots the yields (interest rate) of bonds with equal credit quality but differing maturity dates. Typically bonds with longer maturities have higher yields.

An inverted yield curve occurs when short-term yields are higher than long-term yields.

Yield: The level of income on a security over a set period, typically expressed as a percentage rate. For a bond, this is calculated as the coupon payment divided by the current bond price.

IMPORTANT INFORMATION

Fixed income securities are subject to interest rate, inflation, credit and default risk.  The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa.  The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.

These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. References made to individual securities do not constitute a recommendation to buy, sell or hold any security, investment strategy or market sector, and should not be assumed to be profitable. Janus Henderson Investors, its affiliated advisor, or its employees, may have a position in the securities mentioned.

Past performance does not predict future returns. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.

The information in this article does not qualify as an investment recommendation.

There is no guarantee that past trends will continue, or forecasts will be realised.

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