Artful Dodger

The Federal Open Market Committee (FOMC) voted unanimously to raise short-term interest rates another quarter point, bringing the target for the fed funds rate above 2% for the first time since just prior to the week when Lehman Brothers failed ten years ago. Chairman Jay Powell gave one of the most politically savvy press conferences I have ever seen. He affirmed the economy’s strength while acknowledging that the economy is still not delivering as much as it might for all Americans. He underscored that although the FOMC removed the term “accommodative” when describing policy, it has no intention of actually tightening monetary policy yet.

He appeared simultaneously humble and skeptical about the Federal Reserve’s forecasts. He acknowledged that the best they can do is react to the economy as it evolves. This is at the same time that the economy is surprising the FOMC on the upside. That means the members are currently focused more on upside risks and chasing the economy higher. The reality is that such a policy, however justified because of uncertainties surrounding the outlook, is reactive. Historically, this has led the Fed on a path of overshooting to the upside on interest rates.

The data on the economy comes out with a lag, which means that the FOMC is always playing catch-up. By the time the economy falters, officials will likely be slow to ease, especially given the delayed effects of policy shifts. It can take six to twelve months for a shift in rates to affect the overall economy.

Powell artfully dodged questions on everything from tariffs to ballooning deficits and emerging markets. He said that the Fed has no authority over tariffs and deficits; those decisions belong to the administration and Congress. He said he hopes the escalating trade tensions will be resolved in a favorable manner for the U.S., with more open and fair trade. The tariffs have yet to show up in the aggregate data; he said policy makers cannot respond until then. The effects of uncertainty on investment related to escalating trade tensions are particularly hard to predict.

Rising debt and deficits were viewed with more caution, adding to growth today but potentially at a price down the road. They could limit the extent to which the Fed will be able to keep the economy in a sort of Goldilocks world as we move forward but, again, that is out of the Fed’s “lane” when it comes to decision making.

When it comes to the current problems in emerging markets, Powell repeated that the Fed’s primary job is the domestic economy. He acknowledged, however, that the FOMC cannot ignore growth in the rest of the world; what happens abroad doesn’t always stay abroad.

Powell is so far much more passive than his predecessors on advising Congress and the administration about outcomes from their policy decisions. That is a plus, given the politically charged environment.

Bottom Line
Chairman Powell showed justifiable humility about the Federal Reserve’s ability to predict the economy; he wants to use a gradual approach to raising rates to limit the spectrum for mistakes in uncharted territory as the Fed moves to “normalize” policy. That said, a reactive Fed policy is essentially like using the rear-view mirror while driving; the chance of overshooting remains the largest risk.

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