Federal Reserve policymakers almost unanimously agreed to leave rates unchanged at their meeting last month, but remained divided on their next steps. “Several” countries were open to rate hikes if inflation remained high, others were inclined to support further cuts if inflation retreated as they expected, and the entire table grappled with the emerging implications of artificial intelligence for the economy.
The divisions evident from readings from Fed Chairman Jerome Powell’s penultimate meeting as head of the U.S. central bank underscore the challenge ahead for former Fed Governor Kevin Warsh, President Donald Trump’s pick to take over from Powell in May, in convincing the policy-setting group to back the rate cuts Warsh and Trump say are necessary.
The Federal Open Market Committee’s decision last month to keep its benchmark interest rate in the 3.50%-3.75% range was shared by “nearly all” policymakers, according to minutes of its Jan. 27-28 meeting released Wednesday. But the views expressed there included a dose of AI optimism about coming productivity growth and the resulting fall in inflation, and a mirror image of concerns that AI investments posed financial risks based on rising asset valuations and the involvement of “opaque private markets.”
“Several participants … expected that higher productivity growth linked to technological or regulatory developments would put downward pressure on overall inflation,” the minutes said. “However, most participants warned that progress towards the Committee’s 2% target could be slower and more uneven than generally expected, and believed that the risk of inflation continuing to rise above the Committee’s target was meaningful.”
AI brings great potential, risk and uncertainty
The debate at the January meeting reflected a potentially challenging time ahead for Powell and then Warsh, as policymakers grapple with the flood of near-term economic data while trying to predict how and how quickly the potentially deep, AI-driven restructuring of the economy plays out.
For example, the Fed staff analysis expects strong growth to continue, an expectation consistent with what the Trump administration says its policies will achieve. But staff believe growth will “exceed potential,” and they expected higher inflation, “reflecting expectations of tighter resource use.” That runs counter to the idea, already endorsed by Warsh, that productivity gains will develop quickly enough to support stronger growth with less pressure on prices.
With AI seen as a source of great potential, risk and uncertainty, the Fed’s decision last month to pause monetary easing seemed appropriate to assess where the economy stood after 75 basis points of interest rate cuts last year, the minutes said.
Only a “few” policymakers supported another move at the meeting. Fed Governors Christopher Waller and Stephen Miran both cast dissenting votes in favor of a rate cut, based on concerns that the labor market is at risk of weakening.
In addition, opinions were divided among the other seventeen officials. For example, the minutes mentioned for the first time possible rate hikes if inflation remains above the Fed’s 2% target. The price is currently about one percentage point above that level.
While there is widespread expectation of an expected easing in inflation this year, which is expected to pave the way for further rate cuts, the minutes say that “several participants indicated that they could have supported a two-sided description of the Committee’s future interest rate decisions that reflected the possibility that upward adjustments to the target range for the Federal Funds Rate could be appropriate if inflation remains above the target level.”
“Some” others felt that interest rates should be suspended “for a while” while they waited for new inflation and economic data, with some of that group arguing that cuts may not be appropriate at all until there are indications that “disinflation is back on track.”
“Several” officials, on the other hand, said their basic outlook for inflation and the economy includes further rate cuts.
“Policymakers are moving in the opposite direction with inflation still above the Fed’s target. They can’t even agree on whether current rates are restrictive or neutral. The next chairman could have a tough job building consensus,” said David Russell, global head of market strategy at TradeStation.
Succession to Fed leadership
The minutes cast the debate at the January meeting in a hawkish light, when officials voted to keep the policy rate steady at the current range and indicated it could remain there for some time.
Following the release of the minutes, investors continued to hold on to bets that the Fed will leave its policy rate unchanged until the June 16-17 meeting, which is expected to be Warsh’s first, with rate cuts of a quarter of a percentage point expected during that session and September’s.
Market prices do not reflect any chance of an interest rate increase in the near future.
The June meeting could be Warsh’s first as Fed chief if he is confirmed by the U.S. Senate in time to take over when Powell’s term as central bank head ends.
The Fed’s next meeting is scheduled for March 17 and 18, where policymakers will present updated economic and interest rate projections.
Data releases since the January meeting have done little to resolve the debate over whether the Fed should prioritize putting further downward pressure on inflation by leaving borrowing costs where they are or supporting jobs and economic growth with cheaper credit.
Consumer price inflation was weaker than expected in January, but job growth for the month exceeded expectations and the unemployment rate fell, with most officials saying they expect moderately strong economic growth to continue.
(Reporting by Howard Schneider; additional reporting by Ann Saphir; Editing by Andrea Ricci and Paul Simao)
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