Mike Tyson famously said, “Everyone has a plan until they get punched in the face.”
Surprisingly hot US inflation so far this year has been — at best — a gut punch to the Federal Reserve’s plan to deliver rate cuts this year to reduce its policy rate from the highest level in over two decades. At worst, it’s been a knockout blow.
Back in December, the central bank expected that core PCE inflation would decelerate from 2.8% to 2.4% over the course of this year. That forecast was raised in March to 2.6%. And with inflation having surprised to the upside since then, the risks are tilted toward another upward revision when the central bank updates its projections in June.
Markets have reacted strongly to the short-term resurgence of inflationary pressures. In January, traders were pricing over 170 basis points of easing from the US central bank this year; that has since receded to about 40 basis points. There has even been a creeping tendency to price the Federal Reserve’s next move as a hike: Options markets suggest roughly 15% odds of the Federal Reserve’s policy rate being higher than current levels around year-end.
Faced with stubbornly high price pressures, Federal Reserve Chair Jerome Powell is signaling the central bank is still far from fighting fire with fire and aggressively punching back to attempt to slow the economy and inflation. Instead, he’s borrowing a tactic from another prominent pugilist: Muhammad Ali’s “rope-a-dope” strategy.
Basically? Take the hits, ride it out, wait until the opponent is exhausted.
The message is that the fight against inflation will be won over time without the need for further policy tightening.
Several times during his press conference, Powell was asked about what would make the Federal Reserve deliver rate hikes, rather than cuts, going forward. According to Powell, it’s “unlikely” that the Federal Reserve’s next move would be an interest-rate increase, and that the policy discussion inside the central bank is focused on how long to hold rates at this level (before lowering them).
The bad-news story of inflation in 2024 has also been accompanied by some more favorable developments: Economic growth has been more robust than anticipated. And while some labor-market metrics have cooled and are normalizing toward prepandemic levels, overall conditions in the job market remain strong by historical standards. Taken collectively, this suite of macroeconomic outcomes would suggest that policy rates above 5% may not be doing enough to cool economic activity and, in turn, inflation.
Powell is taking a much more benign view.
“The signal that we’re taking [from the data] is that it is likely to take longer for us to gain confidence that we are on a sustainable path back to 2% inflation,” Powell said, later adding: “My expectation is that we will, over the course of this year, see inflation move back down. That’s my forecast.”
Central bankers often say that they are “data-dependent” — and of course all reasonable people update their views when new information comes to light. But ultimately, monetary policymakers have to be outlook dependent and make decisions based on their expectations for how inflation, the labor market, and growth will evolve in the future, not just what’s happening now. That’s the message Powell is sending in not (over?)reacting strongly to the inflation data.
This strategy of weathering the storm when up against the ropes worked wonders for Muhammad Ali in 1974. Will inflation dynamics behave the same as George Foreman’s arms and just wear down? That’s an open question.
