Best Blog of the Week

The most important takeaway from the Federal Reserve's latest meeting is not that the benchmark federal funds interest rate was held steady. That was expected.

Instead, what stands out from the meeting are signs that Fed policymakers are tilting slightly hawkish despite fears in financial markets that a recession may be looming. A continuation of that tilt doesn't bode well for lower interest rates anytime soon. It could also land the Fed in a clash with the Trump administration.

The signs start with the policymakers' interest-rate projections. Only 11 of the 19 Fed governors and Fed bank presidents are predicting two interest rate cuts in 2025, down from 15 of 19 in last December's projections. (https://www.federalreserve.gov/…)

Inflation looks worse to these policymakers than it did in December with the median projection at 2.8% compared to 2.5% three months ago. Remember that the Fed has consistently insisted it will resume lowering rates when it's confident inflation is moving toward its 2% target.

Longer term, the median projection is for the Fed's benchmark federal funds rate, which today is between 4 1/4% and 4 1/2%, to take until 2027 to fall to even 3.1%. Recall that DTN's former Lead Analyst Todd Hultman said last September that getting the fed funds rate below 3% was critical to taking pressure off the farm economy. (https://www.dtnpf.com/…)

With inflation sticky, the one thing that might have pushed the Fed to resume lowering rates was the possibility of a recession. But policymakers expressed no worries about the economic outlook despite recent consumer sentiment statistics that have stoked recession fears in some investors.

While lowering their GDP growth forecast for 2025 to 1.7% from 2.1%, they began their post-meeting statement by saying,
"Recent indicators suggest that economic activity has continued to expand at a solid pace. The unemployment rate has stabilized at a low level in recent months, and labor market conditions remain solid." (https://www.federalreserve.gov/…)

Thanks to the Fed's confidence in the economy, the stock market closed up after the Fed's announcement. At least some Wall Street analysts, however, still think there's bad economic news coming.

If they're right, the Fed will find itself in a tricky situation. Usually, a weak economy brings inflation down, enabling the Fed to cut rates while being faithful to both sides of its dual mandate -- maximum employment and stable prices.

If, instead, the economy weakens significantly while inflation remains elevated -- a situation known as stagflation -- the Fed would have to choose between fighting inflation, which would entail leaving rates high or even raising them, and boosting the economy, which would mean rate cuts. The Fed couldn't have it both ways.

If it chose to fight inflation, it could run up against a president who wants lower rates and who thinks he should have a say in interest rates. The Fed's independence would be at stake. (https://www.dtnpf.com/…)

The one step the Fed took that looked dovish was to slow the unwinding of its $6.8 trillion balance sheet.

After acquiring Treasury and even mortgage debt to stimulate the economy in response to downturns, the Fed has been letting those assets mature without replacing them at the rate of $60 billion a month -- $25 billion in Treasuries and $35 billion in mortgage instruments. Starting in April it will only allow $5 billion a month in Treasuries to expire without replacement.

The effect of the shrinkage is to squeeze the reserves commercial banks have to play with, which is deflationary. By slowing the shrinkage, the Fed isn't trying to ease monetary policy, however. It's avoiding problems in the overnight lending market that could for technical reasons arise when Congress raises the federal debt ceiling this summer. (https://www.wsj.com/…)

The one vote against the Fed's latest actions was by Fed governor Christopher Waller. His objection wasn't to the decision to hold rates steady but to slowing the pace of decline in the Fed's asset holdings. Waller has been speculated to be campaigning to replace Fed Chair Jerome Powell, whose term as chair expires next year.

It will be interesting to see whether the Fed's hawkish tilt survives the economic statistics of the next few months. Though the stock market's immediate reaction was positive, many on Wall Street don't share the Fed's optimism about the economy. No one wants a recession, but if we get one the Fed's next set of projections could look very different.

Urban Lehner can be reached at urbanize@gmail.com

(c) Copyright 2025 DTN, LLC. All rights reserved.