Fed More Flexible Over Timing of Interest Rate Moves

The Federal Open Market Committee (FOMC) voted unanimously to raise short-term interest rates one quarter point to a range of 1.75% to 2%. They upgraded their consensus estimate for growth and lowered the estimates for unemployment. The FOMC increased its consensus for the number of interest rate hikes in 2018 to four, up from three. Our forecast has been for four rate hikes this year since 2017 so we have been expecting the FOMC shift. 

What was unusual in the forecast was the fact that inflation was not revised up as much as the growth and unemployment forecasts would suggest. Chairman Jay Powell expressed a willingness to tolerate inflation slightly above the 2% target (2.1%) which he expects to occur this summer, largely due to higher energy prices. He argued for a largely benign outlook on inflation with the offset of investment, productivity and labor force participation increasing. He attributed a portion of those shifts to the reactions by businesses and workers to recent tax cuts. So far, waiting for labor force participation to pick up has been a bit like waiting for Godot. 

Significantly, the Fed dropped its forward guidance indicating that policy would remain accommodative for some time. This is an acknowledgement that the Fed expects to move from easy to tighter monetary policy over the next year or so. 

Chairman Jay Powell announced that he will start including a press conference after every meeting starting in January 2019. He was careful to note that the move to make each meeting “live” - one in which they could shift interest rates - does not signal a change in the pace of rate hikes. It will provide the Fed with more flexibility on rate decisions at a point in time when the risks of overheating and recession will both be rising.

Powell was cautious in his answers to questions about the risks posed by tariffs. He said there is concern but that no signs of the impact have appeared in the data yet. 

Chairman Powell kept his cards close to his vest and continued to color inside the lines with his comments. He can be more plainspoken and get away with saying less as a noneconomist than an economist.  There were times when he was deliberately vague in his answers. This posturing will serve him well as the Fed moves from an accommodative to tightening stance. I have never seen an administration or Congress welcome shifts in monetary policy that bite. Powell is doing what he can to keep a target off of his back when that eventually occur. 

Bottom Line
The economy has strengthened. The Fed is finally in a position to respond to the shifts with higher rates. It remains in reactive mode, which is necessary given the fat tail risks associated with overstimulating on the fiscal front and the downside risks to growth associated with potential tariffs and trade wars. That caution could have a price, which is likely to be higher inflation than the Fed expects.

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