A Somewhat Disappointing Fed?

Strong corporate earnings reports may help the stock market get through a somewhat disappointing FOMC Meeting this week.  The Fed is not expected to cut rates and the Statement will not likely change from December's -- continuing to say that "inflation remains somewhat elevated" and "the downside risks to employment rose in recent months."  However, Powell may present a more balanced view of the risks in his news conference than he has in the past few meetings. 

Powell may feel less compelled to lean toward a Trump-desired policy easing because of the threat to Fed independence stemming from the DoJ's investigation into his Congressional testimony.  Even without this political interference, the US economy appears to be doing well and not needing further monetary policy stimulus.  Evidence to this effect is seen on both the real and inflation side of the economy.  Nonetheless, a Fed ready to ease if needed should be seen as providing positive support for stocks in the background.

The Atlanta Fed Model now predicts 5.4% for Q4 Real GDP Growth, which would be the third strong quarter in a row.  Good-sized gains in October and November Consumption support the model's prediction for Q425 Real Consumption.   Some of the model's predictions of other components of GDP are questionable, however.  So, the model's prediction should be viewed with caution at this point. 

Importantly from the Fed's perspective, the economy's strength may be finally helping the labor market, seen by the ratcheting down in Initial and Continuing Claims in January.  Although a little early, the Claims data suggest a speedup in January Payrolls from December's +50k m/m pace.  Nevertheless, it would be premature for the Fed to change the Statement regarding the labor market at this point -- although Powell may mention the improvement in Claims (thereby damping the downside employment risk in the Statement).

The economy's strength may be a factor in the steady inflation rate seen over most of last year.  The Total PCE Deflator rose by 0.2% m/m in 5 of 8 months since April 2025.  The Core PCE Deflator rose 0.2% in 7 of the past 8 months.  Both rose 0.2% in December.  Their 2.7-2.8% y/y, the longer-term measure Powell likes to refer to, remains above the Fed's 2.0% target.  The shorter-term 3-month annualized increase also is somewhat above target, with Total at 2.5% and Core at 2.3%.

The next couple of CPI reports will be important to see the size of start-of-year price hikes.  Companies could use them as an opportunity to more fully pass through the tariffs.  However, there could have been measurement problems behind some of the large price hikes seen in the December CPI, stemming from the government-shutdown-resulting delays in sampling.  The affected components could settle down in January or February, which month depending on whether bi-monthly sampling is used.  If it is used, then the price jumps in the December CPI could show up in the January CPI to some extent.

All this evidence argues for the Fed to take as wait and see approach to monetary policy.  Whether the tariffs' boost to prices turns out to be one-off should be evident by the Spring.  And, whether AI results in widespread job losses could show up by then, as well.  The window for a Fed easing may open up in a few months depending on how these developments turn out.