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Doves Flock to the Fed

RFP
The Federal Open Market Committee (FOMC) marked down its forecast for growth, inflation and interest rate hikes in 2019. Members voted unanimously to keep rates unchanged in March. The statement acknowledges the weakness in the data that we have seen since the committee last met in January. The Fed now expects no rate hikes in 2019 and one rate hike in 2020.

Separately, the Federal Reserve announced plans to slow reductions in its balance sheet, starting in May. It plans to set a floor for the balance sheet by the end of September. The Fed also revealed a preference to hold Treasuries over mortgage-backed securities. Starting in October, the Fed will replace most of its maturing, mortgage-backed securities with Treasuries. The remainder may go into mortgage-backed securities but the goal over the longer haul is clearly to hold Treasuries over mortgage-backed securities.

Federal Reserve Chairman Jay Powell underscored the health of the economy in 2019, though it is growing slower than expected the last time that a Fed forecast was published in December. He cited waning fiscal stimulus, slower growth abroad - notably in China and Europe - and ongoing trade tensions including the outcome of Brexit, as reasons for the downgrade in growth. He emphasized the FOMC’s “patience” in making policy decisions, indicating that it may be some time before it has to make another decision (up or down) on interest rates.

Powell clarified that the Fed remains positive on the economic outlook despite the markdown in growth prospects. The Fed has lowered its forecast, which now matches ours. Powell said that the balance sheet is expected to reach a “normal level” in six months. He remained reluctant to characterize reductions in the balance sheet as a tightening of monetary conditions. The Fed has not found the evidence of monetary tightening related to the balance sheet that many in financial markets feared. That said, the Fed is not taking any chances after its communications fiasco in December.

Powell dodged questions that focused too much on downside risks. He argued that there is nothing in the data suggesting that they should move one way or another on rates at the moment. This is the tightrope that the FOMC members have to walk this year. They want to signal that moving to the sidelines is not the start, necessarily, of a rate-cutting cycle that could trigger a vicious cycle in financial markets.

Bottom Line
Powell as the Artful Dodger prevailed. He continued to emphasize that the outlook remains solid despite downward revisions. The chair managed to move the Federal Open Market Committee even farther to the sidelines without suggesting a downturn in growth.

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