Powell's words are mightier than the Fed's dot plot

By Jonathan Levin

The Federal Reserve’s dot plot was supposed to be the main event at Wednesday’s central bank data dump, and — true to expectations — it revealed an upward drift in policymakers’ interest rate expectations over the medium and longer-term. But the market’s interest in “the dots” lasted all of 45 minutes, and ultimately it was Fed Chair Jerome Powell who stole the show by downplaying recent inflation data and suggesting that the encouraging disinflation story remains intact. 
 

Here is Mr Powell’s response to The Wall Street Journal’s Nick Timiraos following the Fed’s widely expected decision to keep rates steady at 5.25-5.5 per cent: “[The two recent months of inflation data] haven’t really changed the overall story, which is that of inflation moving down gradually on a sometimes bumpy road toward 2 per cent. I don’t think that story has changed. I also don’t think that those readings added to anyone’s confidence that we’re moving closer to that point.”
 

 

Even with the caveat at the end, traders heard enough to set the S&P 500 Index on its way to an all-time high.
 

The January and February inflation numbers briefly shook the market’s confidence that the inflation scourge had been eradicated. Over two straight months, the core consumer price index climbed at a 0.4 per cent monthly clip, exceeding economist expectations. But January’s data was marred by obvious statistical noise in the heavily weighted housing component of inflation (which corrected itself in February), and February’s data was pushed higher by notoriously volatile components including airfares and used cars. There may also have been some fleeting impacts from the Red Sea conflict and general start-of-the-year effects (“excess seasonality,” in the statistical jargon).
 

What’s more, the February number won’t look quite as bad for the core personal consumption expenditures index, the Fed’s preferred gauge, which weights product categories differently. As Mr Powell put it, the reports didn’t constitute positive evidence of waning inflation, but neither did they clearly signal a change in trend.
 

That’s the right take, and that’s why the Chair’s words easily overpowered the Summary of Economic Projections, for all its interesting nuggets. Specifically, the median policymaker now sees just six rate cuts by the end of 2025 and nine by 2026. That’s down from seven and 10, respectively, in the previous forecasts.
 

In the longer-run, the median dot now suggests that rates will settle at 2.6 per cent, up from 2.5 per cent previously and the highest since 2019 — a move that may indicate, ever so slightly, the perception of structural changes afoot in the economy. But Mr Powell appropriately warned us to be cautious about jumping to that conclusion.
 

Here’s his response to the Associated Press’s Christopher Rugaber: “In terms of are rates going to be higher in the longer run... I don’t think we know that. I think it’s — we think that rates were generally low during the pre-pandemic, post-global-financial-crisis era for reasons that are mostly important slow-moving large things like demographics and productivity and that sort of thing. Things that don’t move quickly. But I don’t think we know. I mean my instinct would be that rates will not go back down to the very low levels that we saw where all around the world there were long run rates that were at or below zero in some cases.”
 

The shift in the longer-run dots comes after months of private-sector forecasters revising their views upward. In the Federal Reserve Bank of New York’s survey of primary dealers, the median respondent recently revised up their estimate to 2.88 per cent, from 2.75 per cent in December and 2.5 per cent in September. In a sense, policymakers are just playing catchup against the backdrop of a subtly shifting consensus in the market and academia.
 

But confidence intervals are gaping when it comes to longer-term rate forecasts. All in all, there’s little concrete evidence that very much has changed. With May rate cuts seemingly off the table, all that matters now is what the next three inflation reports say before the rate decision on June 12. If they’re good, then the rate-setting committee will get in line with Mr Powell for cuts. And if the inflation data does rediscover its late 2023 trend, those medium and longer-run rate forecasts will be in for yet another revision — this time lower.

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The writer is a columnist focused on US markets and economics. © Bloomberg