Amid a rush of domestic and foreign policy developments that have rattled markets – including the potential for another U.S. government shutdown – the Federal Reserve held steady on U.S. monetary policy.
At the January meeting, the Fed held interest rates steady in a range of 3.5%–3.75% after cutting by 75 basis points over the three previous meetings. Despite the hold, the forward guidance language in the Fed’s policy statement suggests most officials agree that further easing will eventually be appropriate, although there is no sense of urgency. We expect the Fed will remain on hold until later this year, when rate cuts are likely to resume.
Risks diminishing on both sides of the Fed’s mandate
Ahead of the meeting, public remarks by Fed officials suggested that previously divergent views on inflation and labor market risks have converged somewhat. Recent data point to solid economic momentum, improved labor market stability, and relaxing inflationary pressures. This has helped lower the risks to both sides of the Fed’s mandate (maximum employment and price stability) and thus supported the hold-steady approach.
At the press conference, Fed Chair Jerome Powell didn’t appear in a hurry to cut interest rates. He emphasized that rates are now closer to neutral, while data have strengthened the U.S. growth outlook and reduced downside labor market risk. He emphasized that monetary policy is in a good place to react to incoming developments.
The one surprise of January’s meeting was Governor Christopher Waller dissenting in favor of a quarter-point rate cut, along with Governor Stephen Miran (whose dissent was expected). Waller has been advocating for rate cuts in light of what he describes as risks to labor markets along with moderating inflation once tariff effects are excluded. However, his public comments ahead of the January meeting did not appear to make a strong case for another rate cut this soon.
U.S. inflation set to moderate despite firm GDP growth
Our outlook for further rate cuts later this year is based in part on inflation trends. Although core inflation is running around 3% now (versus the Fed’s target of 2%), several forces could help lower inflation even if real GDP growth remains firm. AI implementation and investment, which accelerated in 2025, have coincided with (and helped drive) higher productivity growth and moderating unit labor cost inflation. In time, this should help tame price inflation. Furthermore, tariff-related price increases also appear to have mostly run their course. If inflation data continues to ease, the Fed is likely to gradually ease monetary policy as well.
Broader macroeconomic trends inform our U.S. inflation outlook. In our latest Cyclical Outlook, “Compounding Opportunity,” we discuss how U.S. policy pivots and tariff-related costs prompted a surge in AI adoption and investment as companies aggressively defended margins. Resilient aggregate growth has masked winners and losers, and labor markets have been a key loser. Indeed, as real labor income growth has slowed, the labor market, rather than consumer prices, has realized a greater-than-expected portion of the tariff-related adjustment. This has two longer-term implications for consumer price inflation.
First, although estimates suggest that only around 50% of total tariff costs have been passed on to U.S. consumer goods prices, we think these tariff-related price hikes have largely run their course as the downward adjustment in unit labor costs helped make up the difference for companies. This means we are probably at or close to peak goods inflation.
Second, AI-related trends appear to be reducing labor’s share of income. In the third quarter, it fell to the lowest level in the history of recorded data, which spans almost 80 years. (Learn more in our 22 January 2026 Macro Signposts, “Why U.S. Productivity Gains No Longer Reach Workers.”) We expect continued AI implementation in 2026 (implementation actually remains fairly low in absolute terms), which will likely keep productivity outpacing nominal wage growth – while unit labor cost inflation sinks below levels consistent with the Fed’s target, and helps moderate price inflation over time.
U.S. housing market dynamics also support disinflation. Slowing household formation (possibly due in part to changes in immigration policy and related demographic trends) coupled with greater multifamily housing supply, especially in the Sun Belt cities, is softening rental demand while housing supply expands. This has reduced nationwide new lease rental inflation below owners’ equivalent rent (OER) for the past year, after it materially outpaced average rents in the wake of the pandemic. New lease rents are now more aligned with the broader measure of OER, which reflects average rents for both new leases and renewals across the U.S. economy. Without more need for average rents to catch up, OER inflation is now poised to undershoot pre-pandemic levels as market rental inflation remains subdued.
Key takeaway: Steady Fed awaits clear signals in the data before it resumes easing
January’s meeting reinforces a familiar Fed narrative: The central bank collectively sees policy as restrictive enough to cool inflation, and flexible enough to absorb shocks as officials wait for clearer confirmation before easing further. With inflation pressures broadly receding – helped by productivity gains, fading tariff effects, and softer housing costs – the central bank is likely to stay on hold for now and resume rate cuts later this year. Unless growth weakens materially or inflation reaccelerates, the next phase of policy is likely to be gradual, measured easing rather than a rapid pivot.
Disclosures
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