Economic Monitor – Weekly Commentary
by Eugenio Alemán

Pay close attention to the Fed Chairman’s press conference

January 24, 2025

Chief Economist Eugenio J. Alemán discusses current economic conditions.

Next week we will have the first Federal Open Market Committee (FOMC) meeting decision on interest rates of the year, where Federal Reserve (Fed) officials are expected to leave the federal funds rate unchanged after cutting the rate by 25 basis points during the last meeting of 2024 in December. At that meeting, we also had the release of the Summary of Economic Projections (SEP) and the dot plot that indicated the Fed expected to cut interest rates twice during 2025. However, financial markets today have priced one rate cut for the entire year as the most probable outcome. No SEP will be released during this meeting of the FOMC so we will have to watch the press conference given by Fed Chairman Jerome Powell after the end of the meeting to try to pierce into what the Fed’s intentions are for the rest of the year.

If the December dot plot is still in play, and we believe it is, then the Fed chairman will probably start a campaign to convince markets of the need to stick to the two rate cuts, even in the face of the current uncertainty given the potential effects of tariffs on inflation going forward. The problem is that he would not say it in simple words, so analysts will have to interpret his comments during the press conference.

We believe Fed officials already included their tariff expectations and believed at that time, i.e., December 2024, that two rate cuts during this year were necessary to keep the US economy growing and inflation continuing its path toward the 2.0% target. However, they know that if tariffs are implemented during this year, then the path to the target will take longer. Thus, in December, they decided to extend the period in which they expect to hit the 2.0% inflation target, as measured by the PCE price index. That is: they moved their timing for hitting the target from 2026, according to the September SEP, to 2027 during the December SEP. This means that they have already baked some of the uncertainty into their expectations for inflation going forward to include the potential for tariffs.

For Fed officials, the biggest issue today is inflation expectations. The first view from the January release of long-term inflation expectations from the preliminary release of the Michigan Consumer Sentiment report was not positive. Long-term inflation expectations increased to 3.3% in the preliminary release from 3.0% in December of 2024. This was the highest rate for long-term inflation expectations since June of 2008. At that time in 2008, inflation expectations were reacting to petroleum prices of almost $134.00 per barrel compared to today’s price of about $76.00 per barrel. Thus, it is clear that petroleum prices and/or gasoline prices are not what are driving inflation expectations higher today—the main driver of the increase in long-term inflation expectations today is potential tariffs. However, today’s Michigan Consumer Sentiment Index’s final release showed that long-term inflation expectations increased somewhat but not as much as it was shown in the preliminary release early this month, to 3.2%, which was the same rate we had in November of 2024. Still high, but not as high as in the preliminary release.

It is true that December’s Fed expectations regarding tariffs as well as the potential effects on inflation could be incorrect. This means that the Fed may revise them in the coming months. However, based on current information, we believe that two rate cuts for this year are still in line with the achievement of the Fed’s inflation target of 2.0%, which has now moved to 2027.

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Consumer Price Index is a measure of inflation compiled by the U.S. Bureau of Labor Studies. Currencies investing are generally considered speculative because of the significant potential for investment loss. Their markets are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising.

The National Federation of Independent Business (NFIB) Small Business Optimism Index is a composite of ten seasonally adjusted components. It provides a indication of the health of small businesses in the U.S., which account of roughly 50% of the nation's private workforce.

The producer price index is a price index that measures the average changes in prices received by domestic producers for their output. Its importance is being undermined by the steady decline in manufactured goods as a share of spending.

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