The Federal Reserve Open Market committee decided to keep the fed funds target interest rate unchanged—at a level of 1.50-1.75%. This was widely anticipated as Fed committee members, through various speeches and other comments, have been hinting that they’re essentially ‘done’ with rate cuts for the time being, absent any further deteriorating data. Fed funds futures predicted a 98% chance of this outcome, while only a 65% chance of rates staying in this range next year through June, and 40% by next December (both dates feature increasing odds of at least one more quarter-percent cut). The vote was unanimous, with no dissentions.
The formal statement was little changed from the October meeting, noting the current policy was ‘appropriate’ for current conditions, with strength in jobs and household spending, but also weakness in business fixed investment and exports. The language also specifically mentioned the incoming data points of ‘global developments’ (i.e. trade) and ‘muted inflation’ (i.e. inflation is not high enough for their liking. The ‘dot plot’ showed no change in rates through next year, although these have been shown to have little predictive value.
The key decision items continue to show mixed results, which has made the Fed’s decisions as of late more complicated:
Economic data: GDP growth for the third quarter was upgraded slightly, to 2.1%, in line with the prior quarter. Expectations for Q4 continue to vary, from a low of under 1% to a trend-like 2%, based largely on the most variable inputs such as manufacturing data and export activity. Manufacturing sentiment surveys and actual industrial production have vacillated, but remain challenged. This is in keeping with corporate sentiment that continues to appear reluctant to take on capital spending projects in light of uncertainty surrounding U.S.-China trade, as well as how long this particular business cycle has progressed.
Inflation: Inflation continues to ‘struggle’, although year-over-year levels are coming in at 2.0-2.5%—right around the 2% Fed target. ‘Struggle’ is meant tongue-in-cheek, with a lack of inflation generally preferred by consumers over high inflation, while central bank policymakers tend to see a lack of inflation as a more ominous sign of growth concerns. The low trailing inflation rate is due to a variety of factors, including vacillating commodity prices and global trade, as well as technological change. The latter has tended to depress the price of consumer goods generally, especially when they’re not ‘quality-adjusted’. In short, the Fed has indicated that even if they don’t need to take rates any lower, they also won’t likely raise rates without signs of core inflation picking up. In this effort, the Fed has begun reviewing their internal methods of inflation evaluation, with possibilities like ‘average inflation targeting’ being eased in over the next few years, which would provide a construct for keeping rates lower for longer and ‘bring up the average’, so to speak. Inflation measurement is a nuanced operation, though, with prices for consumer goods, such as computers and TVs, having fallen dramatically over the past decade; on the other hand, healthcare and college tuition costs continue to rise at a far more troubling clip. Inflation seems to depend on individual budgets and demographic status more than broad averages, which is a source of increasing frustration with the Fed’s pinpoint focus on the 2% number.
Employment: The labor market continues to show steady strength, evidenced by the headline measures of a falling unemployment rate, decades-low jobless claims, and decent job additions. The pace of improvement has seemed to flatten, though. An overly-tight labor market can create its own set of issues, when skilled labor becomes harder to find, as the most qualified applicants are already gainfully employed. This can eventually erode productivity and slow down the engine of growth organically over time. For now, the positivity in labor markets would compel the Fed typically to err in the opposite direction, toward a tightening bias, as opposed to an easing one.
Stock and bond markets have each experienced a very strong 2019. This might have come as a surprise to many investors, especially considering the persistent trade concerns, but remains another example of equity markets, in particular, continually climbing a ‘wall of worry’. There has been a good deal written about the effects of monetary policy’s decreasing effectiveness at certain points, notably at low rates seen in the U.S., Japan, and Europe, following a decade of already-easy policy. Following the recent rate cuts, the Fed is left with even less ammunition for easing should a recession surface, since we’re now closer to the zero-bound. It has been presumed that fiscal stimulus would be a better tool than monetary policy in some parts of the globe, with the U.S. tax cuts already having been implemented. However, such policy has been more often used earlier in a cycle to gain traction at the end of a recessionary period, than it is to reach for ‘extra innings’ in an already-long cycle, when levels of debt have been floating higher. Data continues to reflect a lack of recession at the present time, but probabilities have been rising, with a fair amount of qualitative data (like sentiment) being trade negotiation-dependent. Valuations are higher for risk assets than they were in early 2019 (just after the late 2018 correction), but sentiment remains skittish, which a variety of market pundits remind us that historically has not been the sign of a market top, aside from the routine expected corrections.