The March FOMC meeting ended today featured a 0.25% increase in the fed funds rate, taking the range from 1.25-1.50% to 1.50-1.75%. This was largely anticipated due to the strength of economic and labor data in recent weeks, which had moved the probability of a hike to almost certain, and the vote was unanimous. With this being Jerome Powell’s first formal meeting and press conference as chair, markets are most likely looking for consistency, and a measured pace of continuing steady rate hike progress that started under Janet Yellen. In the press conference, comments hinting of inflation fears, worry over fiscal or trade policy, the economy running ‘too hot’ or other signs that the Fed is ‘behind the curve’ in raising rates, would likely not be taken as well by financial markets.
The official statement noted the continuing strength in the labor market and economic activity rising at a moderate rate, while household and business spending has moderated from the prior quarter. Inflation was noted as somewhat mixed, with signs of some increases but generally below target on a broader level. A focus continued to show desire for a tempered pace of rate normalization.
The quarterly summary of economic projections was released and featured minor adjustments from the Dec. 2017 edition. Median GDP estimates for 2018-2019 increased by a few tenths to 2.7% and 2.4%, respectively, staying above the longer-term expected rate of 1.8%. Unemployment rates were also revised to stronger/lower levels, to almost a percent below the long-term expectation of 4.5%. Inflation estimates were little changed, with 2.0% the expectation for the next several years and long-term. Fed funds rate projections were unchanged for this year, at 2.1%, but ticked a few tenths higher for 2018 and 2019, at 2.9% and 3.4%, respectively—with the long-term a tenth higher to 2.9% (implying almost a 1% real rate).
In reviewing relevant policy considerations:
Economic growth: Expectations for Q1 GDP started high, but have since been downgraded to the 2.0-2.5% range by a variety of economists. Much of the forward-looking growth has been expected to originate from increased business spending and hiring in the wake of lower taxes and an easing of regulatory burdens (as noted in the Fed statement, such trends don’t change course overnight). Despite the administration’s high hopes for and discussions of 3-4% growth, there remain structural hurdles in the way, including demographics/labor force growth and low productivity. Faster global growth should provide a boost; however, this optimism has to be tempered by recent inconsistent trade policy and tariff concerns that could prove disruptive.
Inflation: The scare that set the markets off last month was a tick higher in year-over-year wage growth to 2.9%, but the most recent month included data revisions and an updated year-over-year figure falling back down to the mid-2’s. Although there have been individual components that have seen prices tick up, overall CPI is back to 2.2% for headline and 1.8% for core on a trailing 12-month basis—well around the Fed’s 2% target range. The composition of inflation, however, has become increasingly bifurcated over the past decade following the financial crisis, with inflation gains coming from services, such as health care, school tuition, as well as real estate home prices and rents. On the other end, prices for household and technological goods have all fallen dramatically. These trends have mixed costs and benefits for society, companies and for the formal measurement of inflation as an economic tool. This can dilute the meaningfulness of broad average inflation baskets like CPI to some degree, but we must have something as a benchmark, especially to index cost-of-living based payments such as Social Security. Inflation fears continue to stem from the economy eventually running faster than trend, which creates a race between business cycle growth and the Fed’s ability to raise rates quickly enough to contain it without slamming on the brakes to cause a skid. So far, inflation has remained generally contained.
Employment: Labor remains the sweet spot by almost any measure: unemployment rate, payrolls, jobless claims or job openings. We’ve discussed the theoretical place of ‘full employment’ before, and we could well be at or beyond it. Assuming economic growth continues, trends point to a continued improvement in labor conditions, prompting the Fed to continue at (or even speed up) the current pace of monetary normalization—notably if signs of accelerated wage growth again surface.
Status quo seems to be the theme of the day. A strong economy begets a strong economy, in a positive feedback loop of increased business, consumer and market sentiment. Naysayers point to the cycle’s length, tight labor market, appearance of some late-cycle tendencies and relative expensiveness of several investment asset classes as warning signs. The balance could lie somewhere in the middle—which is why ‘Goldilocks’ has been an oft-used descriptor of today’s conditions. The mainstream view currently points to continued good earnings growth (favorable for equities) and a gradual shift higher in interest rates (mixed for bonds and stocks), which can be typical of a later-cycle environment. Growth abroad also continues to improve, boosting the appeal of foreign investments. However, whether or not inflation picks up from its current pace, commodities have also historically performed well late cycle, potentially making them valuable diversifiers.