Fed Chair Powell Lays Out Macroeconomic Scenarios

My colleagues and I on the Northern Trust Fixed Income Team spend a significant amount of time analyzing macroeconomic scenarios and their potential implications for the portfolios we manage. This is a key element of our investment process. So, we were more than a little excited when we heard Federal Reserve Chair Jay Powell speak yesterday at his press conference about different “paths” or scenarios for the U.S. economy and their potential implications for U.S. monetary policy. To us, his chosen scenarios shed light on the Fed’s inclinations and the outlook for interest rates. Let’s take a closer look.

Chair Powell acknowledged that inflation surprised to the upside in the first quarter but maintained his personal forecast that inflation will move back down over the course of this year. Addressing future uncertainties, he laid out three possible scenarios for the U.S. economy, starting with what appears to be his “base case” scenario. This scenario closely mirrors his own forecast, featuring a downward trend in inflation that would give the FOMC greater confidence to start cutting rates.

In the two other scenarios outlined by Powell, the economic outcomes diverge from his personal forecast. We will call them “risk cases.” The first risk case involves inflation proving more persistent than expected, with the Committee gaining no greater confidence that inflation is heading to 2 percent sustainably. He noted that this scenario “would be a case in which it could be appropriate to hold off on rate cuts.” The second risk case scenario features “an unexpected weakening in the labor market,” in which case, he said, cutting rates could be appropriate.

We saw a dovish slant to Powell’s two risk cases, particularly as none involved rate hikes, which he characterized as “unlikely.” We took Powell’s consideration of labor market weakness as consistent with the FOMC’s assessment that the risks to achieving its maximum-employment and price-stability goals are becoming more balanced.

Although Powell avoided specific timelines, we drew some timing clues from other remarks he made at the press conference. For instance, he noted that following higher-than-expected inflation in January and February, the Committee “reserved judgment” until it “had a full quarter’s data.” Using this simple metric and taking into account the significant progress we saw on the inflation front last year, it seems to us that a rate cut in September remains on the table. By then, the FOMC will have seen another quarter’s worth of data, plus inflation readings for July.

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