The Federal Reserve held its target range for the federal funds rate constant in January 2026 at 3.5–3.75 percent. This decision was consistent with market expectations for the path of the federal funds rate, which for weeks had indicated that the Fed would hold rates steady at its January meeting. It is also consistent with rates prescribed by leading monetary policy rules. Notably, Governors Stephen Miran and Christopher Waller dissented from the decision, with both favoring a 25-basis-point cut.

At the post-meeting press conference, Powell pointed to elevated inflation and a stabilizing labor market to explain the Fed’s decision to hold rates steady. He said Fed officials now “see the current stance of monetary policy as appropriate to promote progress” toward both sides of the dual mandate. Previously, Fed officials had expressed concern about the tensions facing the Fed’s dual mandate amid a softening labor market. Powell said that available data show “economic activity has been expanding at a solid pace,” driven primarily by consumer spending and business fixed investment. He acknowledged the lingering effects of last fall’s prolonged government shutdown, but suggested that any drag on activity in the third and fourth quarters of last year will likely be reversed in the first quarter of 2026.

After softening for much of last year, labor market conditions now appear to be stabilizing, Powell explained. He pointed to relatively low and stable unemployment in recent months as evidence that the labor market may be at or near maximum employment. Echoing past statements, Powell acknowledged that the slowing pace of job growth likely reflects changes in both labor supply and labor demand. He said other indicators — such as job openings, layoffs, hiring, and nominal wage growth — “show little change in recent months.”

Powell acknowledged that inflation has remained stubbornly above the Fed’s two-percent target, with PCE inflation likely coming in at 2.9 percent over the 12 months from December 2024 to December 2025. Elevated inflation, he contended, “largely reflects inflation in the goods sector, which has been boosted by the effects of tariffs.” At the same time, Powell emphasized that longer-run inflation expectations remain aligned with the Fed’s two-percent target. Taken together, these claims suggest that inflation remains a concern for Fed officials, but one that is driven primarily by temporary, non-monetary forces.

According to Powell, the current target range for the federal funds rate is “within a range of plausible estimates of neutral” — that is, consistent with neither an overly accommodative nor restrictive stance of monetary policy. Holding rates steady, Powell argued, should help stabilize the labor market while allowing inflation to return to target “once the effects of tariff increases have passed through” to the price level.

By attributing elevated inflation primarily to tariff-driven increases in goods prices, the Fed is implicitly treating today’s inflation as a transitory relative-price adjustment rather than a broader monetary phenomenon. If that diagnosis is correct, a wait-and-see approach may be appropriate. There are, however, reasons to be skeptical. 

Total dollar spending in the economy rose sharply relative to expectations in the third quarter of 2025, a pattern that is difficult to reconcile with a genuinely neutral stance of monetary policy. When nominal spending accelerates at this pace, it suggests that monetary conditions remain accommodative, regardless of how inflation is distributed across sectors.

More troubling is the fact that, despite the surge in dollar spending last year, financial markets are currently projecting two additional 25-basis-point cuts to the federal funds rate over the coming year. Given that inflation is still running above target, it is difficult to see which economic conditions would warrant further monetary easing. Absent a clear deterioration in real activity or a decisive return of inflation to target, additional rate cuts risk reinforcing the very spending pressures the Fed is attempting to contain.

Ultimately, the Fed’s current posture reflects a high degree of confidence that inflationary pressures will fade without further policy restraint. That confidence rests on the view that inflation is largely the result of temporary, tariff-driven distortions rather than excess nominal demand. But if that view proves mistaken, the cost of waiting — and especially of easing further — could be a renewed loss of progress toward price stability. For a central bank whose credibility depends on keeping expectations firmly anchored, misdiagnosing the source of inflation is not a neutral error. It is an error that compounds over time.