Economic Commentary

Executive summary

The Federal Reserve (Fed) left its target federal funds rate unchanged. Similarly, it also maintained the pace of their balance sheet runoff. Both were widely expected by markets.

During the press conference, Fed Chair Jerome Powell carefully walked the tightrope to justify pausing rate cuts in the near term, and steering clear of political questions. He mostly stayed on message and kept his answers brief.

We maintain our view that the Fed will remain on hold for the next few meetings, unlike other major central banks, such as Canada and the European Central Bank, which are continuing to cut their benchmark rates.

Given no change in policy and an uneventful press conference, it’s not surprising that the reactions by U.S. stock and bond markets were largely muted. 

What happened

At its January rate-setting meeting, the Federal Open Market Committee (FOMC) kept its target range for the federal funds rate at 4.25% – 4.50%. Still, that’s one full percentage point (1.00%) lower since September 2024.

It also held the pace of its balance sheet runoff (i.e., quantitative tightening, or QT) steady at $60 billion per month with the monthly redemption cap of $25 billion for Treasury securities and agency mortgage‑backed securities (MBS) at $35 billion.

In his prepared remarks at the outset of the post-meeting press conference, Chair Powell reiterated that the committee was "not in a hurry to lower rates further" in the near term. He also addressed the removal of wording in the press release statement regarding “inflation has made progress toward the Committee's 2% objective,” categorizing the change as language clean-up rather than meant to signal any sort of shift in policy.

Powell also acknowledged better employment reports – with headline job growth above 200,000 in three of the past four months – but also that inflation progress seemingly stalled due to things like egg and energy prices, etc.

Reporters peppered Chair Powell with political questions – about potential tariffs, economic impacts, what-ifs, etc. – related to policies undertaken or proposed by the new Trump administration. In response, he relied on prepared remarks and stayed tightly on message.

Similarly, Powell wouldn’t be pinned down on defining the so-called neutral rate, what it would take to see either more rate cuts or potentially hikes, among other topics. That said, he was quite firm in stating that the Fed wasn’t considering changing their stated 2% inflation target. 

Our take

The Fed moved to the sidelines and Chair Powell didn’t step on any landmines – mission accomplished. He did exactly what was required. The only thing he didn’t say was, “see you in the late spring.”

But the Fed can’t front-run potential policies implemented by the new Trump administration, such as tariffs, or stepped-up immigration enforcement further tightening labor markets, etc. Unfortunately, the Fed needs to wait for those policies to be enacted as the details dramatically alter the impacts on the economy. For instance, targeted incremental tariffs on a limited number of goods from one or a few countries (such as China) would have a modest economic impact compared to larger universal tariffs covering most incoming imports.

Additionally, it’s important to note that other major central banks continued to cut their benchmark rates this week, including Canada, or are expected to, such as the European Central Bank, which meets tomorrow. This adds to the growing interest rate differential between U.S. Treasuries and their equivalents in other developed markets.

Higher U.S. rates (aka rate differentials) are also contributing to the stronger U.S. dollar recently, along with higher economic growth comparatively. While the U.S. dollar hit its highest level since 2022 earlier this month, we think it will largely persist.

Ultimately, Chair Powell reiterated that the Fed isn’t in a hurry to change without a clear reason to do so. Although the outlook for 2025 is unsettled, the U.S. economy remains solid, while the employment and inflation trends continue to behave. That backdrop doesn’t really require any policy changes at this time.

Equity market reaction

U.S. stocks, which were already modestly negative for the day prior to the meeting, briefly dipped. However, stocks swiftly recovered within minutes of Chair Powell starting his press conference.

It’s also important to note that this meeting was held during earnings season. Thus, the market will quickly shift focus to tech earnings as Fed policy appears to be on a holding pattern.

Bond market reaction

Between mid-September and mid-January, U.S. Treasury yields between 1- and 30-year maturities rose sharply higher based on resilient economic activity, heightened fiscal policy uncertainty, and more gradual Fed rate cuts now expected. Yields from 10 to 30 years touched 14-month highs but have since retreated by roughly 20 basis points (0.2%) based on cooler-than-expected inflation data and investors stepping in to capture elevated U.S. yields. Several Fed officials reiterating that gradual rate cuts would likely be appropriate in 2025, also contributed to the recent stabilization in interest rates. In 7 months, the 2-year/10-year U.S. Treasury yields curve has steepened by roughly 80 basis points (0.8%) and remains positively sloped by more than 30 basis points (0.3%).

U.S. Treasury yields initially moved marginally higher in reaction to the FOMC’s official statement. Namely, the removal of language highlighting the Fed’s progress in taming inflation was interpreted as somewhat hawkish. However, Fed Chair Powell’s explanation for the change during his press conference brought yields back down to their pre-rate decision levels. Overall, the bond market’s reaction was very muted and traders’ expectations for two 0.25% rate cuts this year remained largely unchanged.

Interest rates will remain very sensitive to fiscal policy developments and incoming economic data. Concerns around the potential impact of tariffs and immigration policy may create tactical opportunities to shift portfolio duration; however, the many unknowns around fiscal policy support a neutral duration profile for now. Given our expectation that inflation will continue its bumpy cooling process, we still expect the Fed to gradually lower the federal funds rate by 50 basis points (0.5%) by the end of 2025. 

Bottom line

The Fed left monetary policy unchanged and will likely remain on hold for the next few meetings. Additionally, Chair Powell didn’t step on any landmines and stayed tightly on message. We continue to believe that the bar for more rate cuts has increased due to the continued resilience in the economy and the uncertain fiscal policy landscape, which translates into holding rates steady for now.