FOMC meeting, January 27-28

Not a holding pattern: loosely neutral policy in an ongoing easing cycle

• The Federal Reserve held the federal funds rate unchanged at a target range of 3.50%–3.75% at the January 27–28 Federal Open Market Committee (FOMC) meeting. The vote featured not one but two dissents in favor of a 25-basis point (bps) rate cut. Governor Christopher Waller — on President Donald Trump’s shortlist of chair nominees — joined what has become an unfailing dissent from Governor Stephen Miran in favor of additional easing.

• The policy statement seemingly offered a rosy outlook, but Fed Chair Jerome Powell downplayed any perception of excessive optimism, noting ongoing downside risks to the labor market and upside risks to inflation. Powell described the policy rate as being loosely neutral or moderately restrictive, while suggesting that a rate hike was unlikely to be the Fed’s next move. Instead of suggesting the Fed was in an indefinite holding pattern, he instead focused on potential reasons — such as easing inflation in the second half of the year or weakening labor market conditions — that could prompt further Fed easing.

• We continue to anticipate 50bps of easing through 2026, as labor market fundamentals gradually soften and PCE inflation hovers just below 3% in the first half of the year before easing toward 2.5% by year-end. In this context, the first 2026 rate cut is unlikely to occur before June.

Language in the policy statement reflected solid economic activity, still-elevated inflation, and “some signs of stabilization” in the unemployment rate. Guidance on the “extent and timing” of additional policy rate adjustments was preserved, signaling an ongoing pause in the easing cycle. While the statement emphasized risks to both sides of the Fed’s dual mandate, language noting that “downside risks to employment rose in recent months” was removed. During the press conference, Powell stressed that while downside risks to employment and upside risks to inflation had diminished, they “still exist.” He rhetorically added, “Are they fully in balance? Hard to say.”

During the press conference, Powell noted that the FOMC is not trying to articulate a test for when to next cut, or even “whether” to cut at the next meeting. He reiterated several times that monetary policy is well positioned to let the data speak. He noted that there was broad support on the FOMC for holding the federal funds rate constant, “including among non-voters,” and stressed that policy decisions will be made on a meeting-by-meeting basis, guided by incoming data and the evolving outlook.

Powell said that he did not believe any Fed policymaker’s base case was for a rate hike as the next most likely policy move. In that vein, he confirmed that he did not want to overstate the case for reduced risks to the labor market, noting that the labor market is only showing signs of stabilization. Still, he stressed that there is evidence of weakening labor demand across various indicators, and that a notable further weakening in the labor market would argue for loosening policy further. Similarly, he noted that if inflation continues to come down, that would signal scope to loosen policy. Our view — and seemingly the Fed’s — is that personal consumption expenditures (PCE) inflation will moderate in the second half of the year once tariff pass-through is past its peak, providing an aperture for Fed easing.

While the two triggers for further Fed easing are the labor market and inflation, the key constraint is how close monetary policy is to neutral. In this regard, Powell provided insight into his and his colleagues’ positioning: “I think, and many of my colleagues think, it is hard to look at the incoming data and say that policy is significantly restrictive.” Powell himself defined policy as being “loosely neutral or somewhat restrictive.” This suggests there is scope for further fine-tuning of policy toward neutral — potentially around 50bps — should inflation ease and labor market fundamentals soften further.

Overall, while the Fed has been politically pressured to cut rates, it is not pressed by the data. Many Fed officials remain circumspect about recent data, given gaps in collection and distortions associated with the government shutdown. In this context, policymakers are likely to place greater weight on core PCE inflation and the unemployment rate in the coming months. We also stress the risk of a partial government shutdown later this week, which could again disrupt the collection and publication of employment and Consumer Price Index (CPI) data by the Bureau of Labor Statistics (BLS). In particular, the risk of a more pronounced downward bias to CPI inflation is significant, given the BLS’s methodology for accounting for gaps in data collection.

As expected, Powell refrained from commenting directly on the Department of Justice probe involving himself and the Fed, as well as the Supreme Court’s pending ruling relating to Governor Lisa Cook. Despite several questions, he said, “I will simply refer you to the statement I made on January 11. I am not going to expand on it or repeat it,” and, “I have nothing for you on that today.” Pressed on whether he had made a decision to stay on the Fed Board as governor past the expiry of his term as Fed Chair on May 15, he again replied, “No, and I really, once again, have nothing for you on that today.”

Asked for advice for his successor, Powell said, “Stay out of elected politics.” He also emphasized that “our window into democratic accountability is Congress. It is not a passive burden; it is an affirmative, regular obligation,” and added that “Fed staff is the most qualified group of people you have — and will ever work with.”

The views reflected in this article are the views of the author(s) and do not necessarily reflect the views of Ernst & Young LLP or other members of the global EY organization.