Everyone is in “risk management mode”

Jerome Powell emphasized that the Federal Reserve remains cautious and operates in a “risk management mode” as it navigates progress on both sides of its dual mandate. While Powell struck an optimistic tone regarding inflation, he highlighted that the Fed needs to observe further evidence of disinflation before initiating a cutting cycle. Not on a 3- or 6-month basis, but the 12-month downshift is the Fed’s primary target.

According to Powell, the data on inflation seen thus far has been “good enough,” but the Fed requires more consistent evidence of disinflation trends to justify rate cuts. Powell acknowledged the two-sided risks of initiating rate cuts too late or too early. Nevertheless, he indicated that rate cuts are inevitable, although the timing depends on the evolution of economic indicators and inflationary pressures.

Maintaining credibility is paramount for the Federal Reserve, especially in the context of monetary policy decisions. The Fed aims to avoid premature adjustments that could lead to unintended consequences such as reigniting inflation pressures. Loosening monetary policy too soon and too aggressively could potentially destabilize the economy and undermine public trust in the Fed’s ability to manage inflation

But from the market trends perspective, the recent release of favourable ECI data and the significant decrease in major measures of consumer inflation expectations have eliminated both potential risks of runaway price growth – namely, a wage-price spiral and unanchored expectations. Therefore, why delay in reducing policy restrictions?

Regarding market sentiment, there remains a significant probability, close to 50%, assigned to a potential rate cut in March. Given this perspective, the recent Federal Reserve policy event may be seen as a placeholder meeting, allowing officials time to deliberate on the timing of rate adjustments. Investors are eyeing February 13 with particular interest, as the release of the US Consumer Price Index (CPI) could serve as a decisive factor in shaping expectations for a March rate cut.