What Is Powell Thinking?

This question was partially answered yesterday in a speech by Fed Governor Christopher Waller: "This cycle, however, with economic activity and labor markets in good shape and inflation coming down gradually to 2 percent, I see no reason to move as quickly or cut as rapidly as in the past. The healthy state of the economy provides the flexibility to lower the (nominal) policy rate to keep the real policy rate at an appropriate level of tightness."

This suggests that Fed Chair Jerome Powell and his colleagues are still thinking about three rate cuts of 25bps each this year, but are in no rush to start cutting. Today's news supports a more cautious approach to rate cutting:

(1) Middle East. Powell must be concerned about the escalating conflicts in the Middle East. They have the potential to disrupt oil supplies and drive oil prices up sharply in a replay of the two inflationary energy crises of the 1970s. This morning, we learned that Iran launched missile and drone strikes on targets in three countries—Iraq, Syria, and Pakistan. The Mad Mullahs are going ballistic, literally. The only good news is that oil prices remain down and out.

(2) China. China's recent GDP, retail sales, and bank loan reports all confirm that China's economy is weak, which helps to explain why the price of oil isn't soaring. China continues to export deflation to the US and the rest of the world. Today's report on import prices showed that these prices for Chinese goods fell 3.0% y/y during December, weighing on the core CPI for goods in the US (chart).