Restrictive Territory
The year 2024 ends with the Fed keeping monetary policy in restrictive territory. Despite three rate cuts in 2024, with a 25-basis-point reduction in November and a more aggressive 50-basis-point reduction in September, sending the Fed fund rates to 4.25% to 4.5%, which is still above the neutral rate of 3.1% and therefore restrictive.
Why is the Fed keeping rates in restrictive territory?
There is still persistent inflation in core services, which is a level far higher than before the pandemic, including +3.8% year-over-year in November. That figure is higher than the readings in June, July, and September. Moreover, there hasn’t been any progress at all over the past 6 months.
“We Still Have Work to Do Though, Is How We’re Looking at it. We need Policy to remain restrictive to get that Work Done,” said Fed Chair Powell in December’s Federal Open Market Committee FOMC, a Committee inside the Fed responsible for overseeing open market operations and making key decisions about interest rates and the money supply.
“We always try to be careful about not throwing out the numbers we don’t like. It’s just an occupational hazard to say, ‘Look, oh, those high months are wrong.’ What about the low months? We have a very low month in November. It is estimated by many to be in the mid-teens for core PCE. So that could be low. We try to look at not just a couple or three months. We shouldn’t. Our position shouldn’t change based on two or three months of good or bad data,” said Powell.
Food inflation accelerated again could also be another reason why the Fed remains in restrictive territory
Food prices are rising again, albeit at a reasonably low level.
In November, the PCE price index for food and beverages purchased for off-premise consumption rose by 3.0%, annualized from October.
Year-over-year, it accelerated to +1.4%, the biggest year-over-year increase since March, and up from the +1.0% to +1.2% range in the prior months.
Food is not included in the core PCE price index, but it is included in the overall PCE Price index, and the sharp deceleration of food prices was a big contributor to the deceleration of the overall PCE price index, which may also be over as well.
The Fed kept its monetary policy in restrictive territory as energy prices increased in November from October by 3.0% annualized. This was the first meaningful month-to-month increase since April. These are energy goods and services that consumers buy directly, such as gasoline, natural gas piped to the home, electricity, propane, heating oil, etc.
The Fed also highlighted some progress on inflation, hinting the move from restrive policy to neutral rates could come in 2025.
“We have a long string of inflation coming down gradually over time. As I mentioned, I think the 12-month headline is 2.5%, the 12-month core is 2.8%. That’s way better than we were,” said Fed Chair Powell.
The monetary loosening cycle could be moving along slower than anticipated.
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