There were few surprises this week as Jerome Powell took the podium and updated markets about the U.S. Federal Reserve’s rate decision. As expected, rates remained unchanged. Chairman Powell highlighted that he was not overly concerned about the recent spate of firmer inflation. And the Fed’s summary of economic projections (SEP) is still signaling three rate cuts this year – with markets expecting the June meeting to be the kickoff.
But the Fed significantly raised its GDP growth outlook for the year. Powell elaborated that a key contributor was brisk growth in labor supply, with immigration a notable contributor. The Fed expects labor market rebalancing to continue and, in turn, ease wage pressure.
One less noticeable, but important, change in the SEP was the Fed increasing its view of the long run Fed Funds rate. This terminal rate is a combination of the inflation and real rate that is expected to keep the economy humming at a stable pace. Past research and Fed targets suggested 2.5% was about right. But persistent U.S. fiscal deficits and financial conditions that seem less sensitive to Fed rates have led to a rethink. Varying research suggests something in the 3%–3.5% range may be a better target.
For now, the Fed upped its terminal rate to 2.6%. While not a big shift, this is generally the central bank’s approach, to first signal some change and follow it up with incremental revisions. Powell has already weighed in, stating that he thinks “rates will not go back down to the very low levels that we saw” over the last cycle.
Source: U.S. Federal Reserve, 2024.