The FOMC unanimously decided on no policy action upon the conclusion of their January meeting, which was as expected.
The formal statement noted continued strength in the labor market and economic activity rising at a ‘solid’ rate (downgraded from December’s ‘strong’). While household spending has continued to grow, a slowdown in business fixed investment last year was also mentioned. Notably, the committee’s description of being ‘patient’ about determining future changes was newly inserted into the brief note, in consideration of both muted inflation but also global economic and financial developments as of late. In fact, all mention of the ‘gradual increase’ path for interest rates was removed, which was telling.
Interestingly, one change for 2019 is that the Jerome Powell-led Fed will host a press conference with Q&A after all eight meetings, as opposed to only after the four quarterly ‘formal’ variety in past years. While this may not have a major impact on policy, it could give the FOMC more latitude to make more controversial decisions at any of these meetings, since they’ve tended to do so only when a media backdrop was available to further clarify aims. In contrast to the Fed of old, communications and ‘forward guidance’ have become important pieces of their toolkit.
Volatility in several segments over the past few months—including financial markets (volatile stock prices and wider credit spreads), the political environment/government shutdown, trade policy between the U.S. and China and a continued strong dollar—have also added to a general headwind of tightening financial conditions. Such a tightening in overall conditions serves a similar purpose to the Fed raising rates directly, by tapping the brakes on the economy—which can either help the Fed, by doing the job for it, or acting as a hindrance in other cases.
There has also been speculation as to whether the Fed would slow the pace of drawing down their balance sheet of treasury and agency mortgage-backed securities (which it did not, but remains prepared to ‘adjust the details’ of this program over time as needed). Beginning in Oct. 2017, the Fed began the process of unwinding the large quantitative easing program by letting a pre-determined amount of bond assets mature (up to a cap, which has increased in stages), which allows the reduction to be done gradually and avoid market distortions. Since peaking at around $4.5 tril. at the time of the drawdown program’s inception, the current balance sheet size has declined to $4.0 tril. Interestingly, the gradual pace of these drawdowns has not seemed to disrupt bond market supply/demand dynamics on the surface. However, while this has been put in place as a ‘normalization’ program, intended to eventually get the Fed balance sheet to far lower sustainable levels, it does have the impact of ‘tightening’—as increasing treasury/MBS supply and reducing reinvestment demand could have the technical effect of raising interest rates, all else equal. Somewhat fortunately, in a world of low overall interest rates throughout the developed markets of Europe and Asia, other global buyers had stepped in to fill the gap—especially since the cost of currency hedging was reasonable (those low costs have dissipated since, making this a less attractive trade). Long-story short, the Fed may elect to alter their pace of balance sheet drawdown should additional signs of economic slowing occur, resulting in less possible upward pressure on longer-term rates, but also keep the balance sheet bloated for a longer period of time. It’s no secret that the Fed would prefer to keep the balance sheet ‘purer’ by only holding treasury debt, and unload the unique pile of MBS, and removing the more politically-charged implied support of housing markets (which is not in their mandate).
Probabilities for rate hikes in 2019 have fallen sharply, down to about 25% for June and 30% for December (with the latter also including 5% odds of a rate cut—a recently added twist). The laundry list of Fed mandate items hasn’t changed radically over the last few meetings, other than concerns over growth having increased: