Fed holds interest rates steady, pausing rate cuts amid economic uncertainty

The Federal Reserve on Wednesday announced it will leave interest rates unchanged, breaking a streak of three straight rate cuts amid uncertainty over the labor market and inflation.

Fed policymakers voted to leave the benchmark federal funds rate unchanged at its current range of 3.5% to 3.75%. The move follows three successive 25 basis point rate cuts in September, October and December to close out last year.

Economic data showing a slowdown in the labor market along with inflation continuing to run hotter than the Fed's 2% target prompted policymakers to put rate cuts on pause, after they were deeply divided over the decision to cut in December.

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The Federal Open Market Committee (FOMC) voted 10-2 in favor of leaving rates unchanged, with dissents by Fed Governors Stephen Miran and Christopher Waller, who were in favor of 25 basis point cuts. 

Miran has been supportive of deeper cuts than the FOMC has favored since he joined the board while taking leave from his role in the Trump administration. His term at the Fed is set to expire on Saturday. Waller is viewed as a potential nominee for Fed chair and last dissented from an FOMC decision in July, when the Fed held rates steady.

The FOMC's statement noted that data shows the economy "expanding at a solid pace," adding that, "Job gains have remained low, and the unemployment rate has shown some signs of stabilization. Inflation remains somewhat elevated."

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Federal Reserve Chair Jerome Powell said at a press conference that after policymakers lowered rates by 25 basis points at each of the prior three meetings, they "see the current stance of monetary policy as appropriate to promote progress toward both our maximum employment and 2% inflation goals."

Powell noted that the labor market has shown signs of stabilizing as the last three jobs reports showed average declines of 22,000 jobs per month, though the private sector added 29,000 jobs per month in that period. He added the slower growth in the labor supply was due to lower levels of immigration and labor force participation as well as softening demand for labor.

The Fed chair also said that inflation remains elevated, with the personal consumption expenditures (PCE) index up 2.9% over the past year through December. He explained that "elevated readings largely reflect inflation in the goods sector, which has been boosted by the effects of tariffs," while in contrast, the services sector has seen disinflation.

Powell was asked about how close the Fed's current interest rate policy is at or near neutral, and he said that "it's hard to look at the incoming data and say that policy's significantly restrictive at this time," saying that it may be "loosely neutral or somewhat restrictive, you know, it's in the eye of the beholder."

He added that after cutting 175 basis points at the end of 2024 and 2025, the central bank is well-positioned to "let the data speak to us" as they weigh potential interest rate moves at future meetings.

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The chairman was asked by FOX Business' Edward Lawrence whether the effects of tariffs have moved through the economy in terms of price increases, and Powell said that "a lot of it has" based on elevated goods prices.

"Most of the overrun in goods prices is from tariffs, and that's actually good news, because if it weren't from tariffs it might mean it's from demand, and that's a hard problem to solve. We do think tariffs are likely to move through and be a one-time price increase," Powell said. 

"The expectation is that we will see the effects of tariffs flowing through goods prices peaking and then starting to come down, assuming there are no new major tariff increases that are begun, and that's what we expect to see over the course of this year," he added.

Powell was asked about the potential for cutting interest rates at a time when recent quarterly GDP data has shown strong growth, and cautioned that "you need to look at 12 months because quarterly GDP can be very lumpy. You know, GDP was negative in the first quarter last year… Over the year, the numbers were nothing like that, it was more in the mid-twos for the year."

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The Fed's decision to put rate cuts on pause was expected by the market, and the FOMC's statement along with Powell's comments during the press conference signaled that may be unlikely to change in the near term.

"The Fed song remains the same – lower interest rates may be coming, but investors will have to remain patient," said Ellen Zentner, chief economic strategist for Morgan Stanley Wealth Management. "While the Fed's pause may not satisfy everyone, it still leaves a path for cuts later this year. With signs of stabilization in the labor market and inflation holding steady, the Fed is in position to play the ‘wait-and-see’ game."

Charlie Ripley, senior investment strategist for Allianz Investment Management, said that the meeting showed a "recognition that economic data has broadly improved in recent months despite enduring the longest government shutdown in history."

"Perspectively speaking, we saw this meeting as an affirmation from the Fed of what investors were already thinking. Labor conditions are not worsening, growth has accelerated, and inflation has steadied for now," Ripley added. "To put it in other words, policy rates are much closer to neutral against the current backdrop and it's time for a long pause."

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The Fed holding rates steady boosted the market's expectation that rates will be unchanged yet again when the central bank holds its next policy meeting in March. The CME FedWatch tool on Wednesday showed an 86% probability of rates remaining at their current level in March, up from 82.7% a week ago and 46.7% a month ago.