Fed Note:
The March FOMC meeting ended as many predicted—with no change to the fed funds rate, which is currently set at 2.25-2.50%. Regardless, the meeting was closely watched in terms of how the Fed planned to communicate a stance on policy for the remainder of 2019.
The formal statement noted a slowing in economic growth from the last meeting in January, including slower growth in household and business spending, while employment remained strong and inflation remained lower recently. The summary of economic projections, released quarterly, showed a downgrade in the ‘dot plots’ (which are generally averaged visually) to essentially zero implied rate changes for 2019, and perhaps only a handful at best over the next few years.
Investors were also watching for signs of a change in current or future policy regarding the runoff of the large Fed balance sheet (which it announced will taper off and in September). While the runoff had been described as being on ‘autopilot,’ fears have increased over an unreviewed runoff amount becoming excessive, essentially resulting in a ‘tapping of the policy brakes’ at the long-end of the treasury yield curve and perpetuating higher rates than ideal. One tweak is that maturing agency MBS will eventually be invested in treasuries instead—in keeping with the Fed’s preference for using treasuries as a purer policy tool and exiting the mortgage market, the participation in which was less ideal long-term as it implies a nudge toward helping housing markets (not part of the Fed’s mandate).
One very interesting development has been the change in Fed Funds futures market probabilities. Late last year, it was largely assumed the Fed would hike perhaps 1-2 times in 2019, a downgrade from the 3-4 many first expected based on the pace of rate hikes last year. As global uncertainty has increased, including the mixed bag of economic data showing deceleration in a variety of areas, this has since morphed into a market expectation for ‘no change’ this year, which has been in conflict with the Fed’s own estimates. Now, the tide has completely turned, with market probabilities for December showing 70% no change and 30% for a 0.25% or more rate cut. This would have almost unthinkable not that long ago, but worries over a possible slowdown into recession have begun to dominate market psyche. A variety of market strategists continue to believe the underlying economy is stronger than it looks, and could easily still handle a hike or two. Within reason, a few hikes could help the Fed with more ammunition to fight the next recession through room to cut rates at that time as needed.
Also interestingly, the Fed is reviewing its approach toward inflation targeting this year, and it is quite possible they could move toward an ‘averaging’ method. This would treat the 2% policy target as a multi-year objective, as opposed to a full-time anchor. What this means is if inflation were to run below target, such as during a recessionary period, it may be later allowed to run ‘hot,’ for example perhaps a half-percent higher than target during a subsequent expansion—resulting in a net result near target for the cycle as a whole. Such a method would give the Fed greater flexibility for interest rate policy, but not having been used up until now, we don’t know what any potential side effects could be from such a change. No doubt there will be more to come on this discussion.
The dashboard of key Fed mandates shows a little-changed story, despite what one might assume from the whipsaw in market sentiment over the past few months:
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