Federal Reserve Chair Jerome Powell delivered the opening remarks at last week’s Thomas Laubach Research Conference, focusing on the Federal Open Market Committee’s (FOMC) review of its Monetary Policy Framework. The Fed is committed to conducting a public review every five years to ensure the framework remains responsive to changing economic conditions. The last assessment was in 2020, during the Covid-19 pandemic, and the review that is taking place now is expected to result in updates that could shift how the Fed responds to economic and financial developments.

The Consensus Statement

The Federal Reserve’s dual mandate — promoting maximum employment and maintaining stable prices — was established by Congress in 1977 in response to the economic challenges of the 1970s. While the mandate guided monetary policy, it lacked specific metrics for evaluating progress. In 2012, the Fed introduced the Statement on Longer-Run Goals and Monetary Policy Strategy, known as the “consensus statement,” to clarify how it would pursue its objectives.

In response to low interest rates, low inflation, and low unemployment post-Great Financial Crisis (GFC), the Fed began a review of its policy framework in 2019, which ended in 2020. A key outcome was the adoption of flexible average inflation targeting (FAIT), which allowed inflation to exceed the 2% target after periods of undershooting, to better anchor expectations.

The 2020 review also changed how the Fed evaluates labor market conditions. Instead of responding to both upward and downward movements from maximum employment, the Fed began focusing on “shortfalls” from full employment — signaling a more patient stance.

As the chief concern at the time was persistent disinflation, the modifications in 2020 resulted in less reactive policy shifts that were asymmetrically dovish. The economic environment changed soon after these adjustments. The Covid-19 pandemic triggered a surge in inflation, and while the Fed responded, it underestimated the persistence of inflationary pressures.

From the GFC to the Post-Pandemic Era

Today, the Fed faces different challenges. Real interest rates are higher, inflation volatility has increased, and supply-side disruptions are more frequent. Powell recently addressed this shift:

“Higher real rates may also reflect the possibility that inflation could be more volatile going forward than in the inter-crisis period of the 2010s. We may be entering a period of more frequent, and potentially more persistent, supply shocks — a difficult challenge for the economy and for central banks.”

 

 

 

 

 

 

 

 

 

 

 

 

Source: Sage, Federal Reserve, BEA 

The Fed appears ready to revise its framework again. According to Powell, FOMC participants have shown interest in reexamining the language around employment shortfalls and reassessing average inflation targeting. The Fed is also considering changes to how it communicates forecasts and uncertainty.

Refreshing the Policy Framework and Communications

As the Fed reviews its policy framework, several areas may change. The experience of the past few years — marked by a pandemic, inflation, and a delayed tightening cycle — has highlighted the need for a framework better suited to managing supply shocks and inflation volatility. One likely adjustment is to how the Fed approaches average inflation targeting. While FAIT was designed to address inflation undershooting, its application during a period of rising inflation revealed limitations. The language around employment shortfalls may also be reconsidered. The 2019 focus on shortfalls was appropriate in a low-inflation environment, but in today’s context, a more balanced approach may be necessary to avoid the perception of excessive tolerance for inflation in pursuit of labor market goals.

Future iterations of the framework may place less emphasis on past deviations from inflation or employment targets and instead prioritize a more responsive stance. This could lead to quicker policy adjustments and, as a result, greater variability in interest rate outcomes — introducing more volatility into rate markets.

The Fed is also evaluating how it communicates policy. As outlined in Ben Bernanke’s recent Brookings proposal, clearer and more structured messaging could enhance policy effectiveness. One suggestion is a quarterly “Monetary Policy Report Summary,” which would provide a plain-language explanation of the FOMC’s outlook, policy rationale, and associated risks. Importantly, it would also include alternative scenarios to help the public understand how the Fed might respond if its base case proves incorrect. Additionally, given the market’s focus on the “dot plot” as a signal of future rate paths, the Fed may consider revising how it presents its projections for the federal funds rate.

A shift toward a more flexible and less formulaic policy approach could increase uncertainty around the timing and magnitude of rate changes. This may lead to more frequent repricing across financial markets, particularly in interest rates and risk-sensitive assets. While this could present challenges, it also creates opportunities for investors who can interpret evolving policy signals and adjust their positioning accordingly.

 

Disclosures: This is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy or investment product. Although the statements of fact, information, charts, analysis and data in this report have been obtained from, and are based upon, sources Sage believes to be reliable, we do not guarantee their accuracy, and the underlying information, data, figures and publicly available information has not been verified or audited for accuracy or completeness by Sage. Additionally, we do not represent that the information, data, analysis and charts are accurate or complete, and as such should not be relied upon as such. All results included in this report constitute Sage’s opinions as of the date of this report and are subject to change without notice due to various factors, such as market conditions. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.

Sage Advisory Services, Ltd. Co. is a registered investment adviser that provides investment management services for a variety of institutions and high net worth individuals. For additional information on Sage and its investment management services, please view our web site at sageadvisory.com, or refer to our Form ADV, which is available upon request by calling 512.327.5530.

Despite the announcement of new tariffs, long-term inflation expectations—as measured by the 5y5y inflation rate—have remained stable. This rate, which reflects expected average inflation over a five-year period starting five years from now, is a key indicator of market sentiment on long-term inflation and is typically derived from TIPS or inflation swap markets.

From April 2 to May 12, the 5y5y rate stayed flat, even though tariffs are expected to raise costs. Since the November election, the rate has actually declined by 10 basis points to 2.26%.

 

 

 

 

 

 

 

 

 

 

 

 

Source: Sage, Bloomberg

Several factors help explain why long-term inflation expectations have remained stable despite the announcement of new tariffs. First, market uncertainty around the implementation of tariffs likely played a role. Investors may have anticipated that the proposed tariffs would be delayed or softened, a view that was validated when the US and China agreed to a 90-day postponement following in-person negotiations. This delay signaled a potential de-escalation in trade tensions, mitigating the perceived inflationary risk.

Moreover, the nature of tariffs themselves may limit their impact on long-term inflation expectations. Tariffs are generally seen as a one-time shock to prices, influencing short-term inflation more than the long-term trajectory. As such, markets may have discounted their relevance to the broader inflation outlook.

Additionally, concerns about the broader economic impact of tariffs may have further dampened inflation expectations. Tariffs can compress corporate profit margins and weaken aggregate demand, both of which are deflationary forces. Rather than fueling inflation, these effects could signal slower economic growth, which tends to suppress price pressures over time.

Another important factor is the behavior of energy markets, which are closely tied to inflation expectations. Oil prices have declined amid increased supply from OPEC+, contributing to a more subdued inflation outlook. Since energy is a key input cost across the economy, falling oil and gasoline prices can exert downward pressure on inflation expectations.

 

 

 

 

 

 

 

 

 

 

 

 

Source: Sage, Variant Perception, Bloomberg 

Finally, confidence in the Federal Reserve’s credibility appears to be anchoring long-term inflation expectations. Despite recent economic volatility, the 5y5y inflation rate has remained close to the Fed’s 2% target. This suggests that markets still trust the Fed’s ability to maintain price stability over the long run, even in the face of fiscal and geopolitical uncertainty.

 

 

 

 

 

 

 

 

 

 

 

 

Source: Sage, Bloomberg 

While tariffs typically signal upward pressure on prices, markets appear unconvinced that recent trade developments will meaningfully alter the long-term inflation landscape. The resilience of the 5y5y inflation rate underscores investor confidence in the Federal Reserve’s ability to anchor inflation expectations and reflects broader forces — like global energy prices and demand outlooks — that continue to exert a stronger influence on long-term inflation sentiment than short-term policy shifts.

 

Disclosures: This is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy or investment product. Although the statements of fact, information, charts, analysis and data in this report have been obtained from, and are based upon, sources Sage believes to be reliable, we do not guarantee their accuracy, and the underlying information, data, figures and publicly available information has not been verified or audited for accuracy or completeness by Sage. Additionally, we do not represent that the information, data, analysis and charts are accurate or complete, and as such should not be relied upon as such. All results included in this report constitute Sage’s opinions as of the date of this report and are subject to change without notice due to various factors, such as market conditions. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.

Sage Advisory Services, Ltd. Co. is a registered investment adviser that provides investment management services for a variety of institutions and high net worth individuals. For additional information on Sage and its investment management services, please view our web site at sageadvisory.com, or refer to our Form ADV, which is available upon request by calling 512.327.5530.

The current geopolitical climate has injected an extra dose of unpredictability for economic participants, as investment and consumption decisions for everyone have been clouded by trade wars and fiscal policy. Sentiment on the economy is understandably depressed, weighed down by uncertainty; however, real economic data remains expansionary, and should be able to withstand geopolitical stress and tariff concerns over the next few months.

Labor market data last week was solid, with payrolls growing by 177,000 jobs in April, handily beating expectations. The unemployment rate remained near a healthy 4.2% rate, and while it is too early for tariff uncertainty to affect employment, it is clear that the economy is on sound footing.

Source: Sage, Bureau of Labor Statistics

Consumer sentiment on the outlook for jobs, however, is a different story. The most recent Conference Board Consumer Confidence Survey results indicated that 32% of respondents expect there to be fewer jobs in 6 months, which is the highest reading since the Great Financial Crisis.

Source: Sage, The Conference Board 

Dynamics around inflation are similar, as the recent core PCE (personal consumption expenditures, excluding food and energy) release continued to show a moderating pace of inflation, with core PCE up 2.6% on an annualized basis.

Source: Sage, The Bureau of Economic Analysis

Consumer sentiment, however, reflects a deep concern for the future path of inflation. Survey measures of expected inflation have ticked higher in recent months.

Source: Sage, The Conference Board, FRB Atlanta 

It is evident that uncertainty is weighing on sentiment, but the effects on underlying economic activity have yet to be seen. This is natural, as the impact of tariffs, whatever they end up being, will take months to materialize in the hard economic data readings.

How does this affect markets and, in particular, interest rates? We believe the FOMC will continue to display patience in resuming rate cuts until the second half of this year, if inflation and growth continue to decelerate. The variance of outcomes for the economy will be wide, as tariffs, tax cuts, and fiscal deficit developments will all serve as catalysts for the economy and markets through the summertime.

 

Disclosures: This is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy or investment product. Although the statements of fact, information, charts, analysis and data in this report have been obtained from, and are based upon, sources Sage believes to be reliable, we do not guarantee their accuracy, and the underlying information, data, figures and publicly available information has not been verified or audited for accuracy or completeness by Sage. Additionally, we do not represent that the information, data, analysis and charts are accurate or complete, and as such should not be relied upon as such. All results included in this report constitute Sage’s opinions as of the date of this report and are subject to change without notice due to various factors, such as market conditions. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.

Sage Advisory Services, Ltd. Co. is a registered investment adviser that provides investment management services for a variety of institutions and high net worth individuals. For additional information on Sage and its investment management services, please view our web site at sageadvisory.com, or refer to our Form ADV, which is available upon request by calling 512.327.5530.