While investors and institutions were digesting the results of Tuesday’s elections, the Fed was meeting to determine the path forward for rates.  Following on the 0.5% (50 basis points) start in September, the Fed cut rates by a further 0.25% today and the markets are forecasting another cut to come in December, but the odds of that move have ticked lower. 

Today’s statement saw a few alterations from the September meeting, mostly notably removal of language that the “Committee has gained greater confidence that inflation is moving sustainably toward 2 percent” and a striking of language that previously highlighted “progress on inflation and the balance of risks”.  Powell was asked about these changes during today’s press conference and made clear this was not a reflection of a weakening outlook, but rather a shift away from the forward guidance language that the Fed was using to signal the trigger to start rate cuts. Now that cuts have begun, the Fed no longer needs further confidence, but is focused instead on if the incoming data suggests any notable shifts on either inflation or employment as rate changes make their way through the system.

Inevitably, questions in the press conference moved towards the election results, and how the Fed will respond to the increased likelihood of tax cuts and higher tariffs which could impact the path of inflation. In short, Powell stated that the election results have no impact on their short-term views.  The Fed does not know what – or when – policy changes will be implemented under the new administration and has no plans to speculate. When policy changes arrive, the Fed will model for projected impacts, but they are just one piece in a dynamic economy. In the meantime, the Fed plans to move carefully and patiently.

While the Fed continues to look at the same inflation metrics that caused it to first miss the rise in inflation following COVID, and then overestimate the pace at which inflation would come back to trend, we believe the money supply remains the single most important indicator on inflation’s path forward. The M2 measure of money has been rising at a gradual pace after falling into contraction territory for much of 2022-23, and how M2 growth progresses from here will dictate if the Fed has room for further rate cuts or sees a re-acceleration of inflation as was seen when the Fed declared a premature victory on inflation back in the 1970’s. 

If M2 growth remains modest, both inflation and economic growth will slow, but the Fed will have room to continue cuts. If, however, rate cuts lead to a rapid rise in M2 growth, the Fed has shown an active neglect of the warning signs that would have preempted this inflation debacle to begin with.  We will continue to watch – and report – on the money supply, and the ongoing ramifications it has on the economy as a whole.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

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