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Fed Fails to Calm Markets

RFP
The Federal Open Market Committee (FOMC) raised rates a quarter point today. The target range on the fed funds rate is now 2.25-2.5%. The Fed also downgraded the consensus forecast for 2019, and reduced the trajectory on 2019 rate hikes from 3 in September to 2 today. Today’s vote was unanimous.

Those actions have eased market concerns about the Fed overshooting on rate hikes. Reaction from financial markets was negative, however; the move down in rate hikes was not enough of a dovish signal for them. Markets seem concerned about the bifurcation of rate hike expectations laid out in the dot plot, with more hawkish members of the Fed standing pat. Another sticking point was that the Fed said it expected some “further gradual increases in the target range for the federal funds rate.” Most market participants expected that line to be removed to underscore the Fed’s intent to pause after today’s hike. The Fed did modify the statement, however, to reflect the change in the rate trajectory by inserting the word “some” before its expectation of gradual rate hikes.

What was lost in translation for financial markets is Powell’s emphasis on flexibility regarding future rate hikes. He explained that the Fed will be monitoring the data carefully to ensure the economy is evolving as the Fed expects. He said that the Fed is “data dependent,” which is fedspeak for uncertainty. The Fed shifts to being “data dependent” when it has greater uncertainty about both the outlook and the appropriate trajectory of rate hikes that should accompany that outlook. Powell also stressed that the forecast on rate hikes should NOT be taken as a signal on policy given the uncertainty surrounding the outlook.

Chairman Powell emphasized the Fed’s optimism regarding the economy. The pending slowdown in growth is not expected to be enough to prevent further declines in the unemployment rate. Hence, the Fed’s view that it can moderate hikes while it continues to reduce its balance sheet. Powell also said that the fed funds rate is now at the low range of what the Fed considered neutral.

Powell further acknowledged that business leaders are more concerned about the outlook than they have been in the past. He argued that the Fed is watching that change in sentiment, but is waiting to see a larger shift in the economic data. Markets worry that the data is released with a lag and that the Fed could risk overshooting by waiting for a more dramatic slowdown to show up in the data.

That said, Powell is clearly willing to pivot on policy. It is not clear that the Fed has the tools to avert another recession. Indeed, there are many reasons to be worried about a recession that transcends Fed actions. The most notable issues are tariffs, trade war risks, and weakening growth abroad. The US is not an island; what happens abroad will ultimately show up on our own shores. The threat of trade wars and tariffs are the primary culprits.

Bottom Line
Chairman Powell has pivoted and is intent on being more flexible with regard to rate hikes going forward. Much of that flexibility was lost in translation for financial markets because the Fed remains optimistic about growth. This begs the question as to whether the Fed can “win” in the current environment. Markets would also have punished the Fed if Powell said he believed the slowdown would derail the expansion.

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