Fed’s Pause to Last Longer Than Average

October 30, 2019

Coming into today’s FOMC announcement and press conference, Fed watchers correctly coalesced around a view that the Fed would chop 25 basis points off its federal funds rate target for the third time since July 31 but at the same time signal a pause in this easing cycle. The released statement didn’t discredit that presumption. The targeted range floor was lowered to 1.5% from 1.75%, and forward guidance wording was modified in such a way as to take attention from the next scheduled meetings by deleting the expression “as the Committee contemplates the future path of the target range for the federal funds rate… ”

A pause after a sequence of rate changes in the same direction implies a period without changes followed by a continuation of the cycle in the same direction as before. The pause can be lengthy such as the full year that elapsed between the cuts of December 2015 and December 2016. Other times, only a single meeting gets skipped. And sometimes, the pause turns out not to be a pause at all but rather the end of one policy cycle in which case the interval without a rate change is the calm before a rate reversal.

In the subsequent press conference today, Fed Chairman’s Powell’s responses suggested that not only is the federal funds rate unlikely to be changed at the final 2019 meeting scheduled in December, it may in fact stay at 1.5-1.75% for some time longer into 2020.¬† Moreover, the direction of the next policy change is unclear. Powell pushed back against quite diverse scenarios while remaining consistent in the position that the current rate level is appropriate and probably will remain so for an extended span. He clarified that it would take a material reassessment of the Fed’s outlook of continuing moderate growth, strong labor market conditions and inflation running near the 2% goal with symmetric risks. The baseline scenario is much as it was when the second rate cut occurred six weeks ago, but adverse risks surrounding the baseline are less pronounced now than then. Powell said a no deal Brexit looks less likely and that the Phase I trade accord with China has also been a potentially beneficial development. Alternatively, Powell underscored that the Fed takes measures of expected inflation very seriously and recognizes the danger that prolonged sub-2% actual inflation could cause expected inflation to slip lower. The Fed will fight such slippage in price expectations.

And when one question tried to pigeonhole the current situation into the 1998-99 experience, he didn’t take that bait, either. 1998-99 saw a double-reversal. Policy had been tightening. The collapse of a Long Term Capital Management, a hedge fund, prompted three quick 25-basis point cuts from 5.5% to 4.75% between September 29 and November 17, 1998. This was followed by 7-1/2 months without a rate change until mid-1999 when the Fed resumed its tightening cycle, and the cycle of rate increases didn’t crest until a 50-basis point increase to 6.5% in May of 2000.

The upshot of Powell’s responses is that monetary officials want to encourage investors and the U.S. government away from speculating on further change in monetary policy strictly as a preventive measure against future risks. It will take some fundamental clear and present¬† change in the perceived U.S. economic outlook to elicit the next monetary policy change. One has to wonder if by drawing at least a temporary line at this point, Fed policymakers are trying to encourage the U.S. Congress and Trump administration to shoulder the burden of improving non-inflationary growth. Other central banks are also signaling that it’s time for fiscal policy to step up. In the U.S. case, however, it’s one thing for central bank officials to take such a stand and quite another for them to stay the course especially if President Trump ramps up his tweeted criticisms of Fed policy.

Copyright 2019, Larry Greenberg. All rights reserved. No secondary distribution without express permission.

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