A strong employment report coupled with hopes that the U.S. and China will call at least a temporary truce in their trade war will allow the Federal Open Market Committee (FOMC) to move firmly to the sidelines at its meeting on December 10-11. The vote to do nothing will be unanimous, a break from the more contentious decisions to cut rates earlier this year.
The FOMC’s forecast for unemployment will likely drop in 2020 and 2021 from what it published in October. Committee members should also lower their estimates for full employment and what they consider the neutral fed funds rate. The economy has been able to operate at a much lower unemployment rate and lower short-term interest rates than anyone ever imagined possible without generating inflation. It’s time for the Federal Reserve to eat humble pie and acknowledge that.
Chairman Jay Powell is expected to be much more relaxed and reassuring than he was a year ago when the FOMC was still hiking instead of cutting rates. He will signal they have no plans on additional rate cuts, but will remain flexible if conditions were to deteriorate again. The threshold to raise rates is still significantly higher than the threshold to cut rates. The Fed has learned the hard way that trade policy can change in the speed of a tweet, one of the major reasons they were forced to cut rates in 2019.
The rate-setting committee has also been humbled by how low inflation remains and would like to see an acceleration in wages in 2020. They really believed wage gains of 3% on a sustained basis would deliver the 2% inflation they were targeting. They were wrong.
The Fed is currently reviewing overall strategy. They are actively considering a catch-up strategy for inflation that would allow the economy to run a little hot if that allowed more people from the sidelines to rejoin the labor force and catch up on earlier wage losses.
Powell has learned to tread cautiously when it comes to the outlook and will not provide many hints on when the Fed will move next. With a little luck, he will get some time off this holiday season, something we all could use.
Separately, former Fed Chairman Paul Volcker, who was known for breaking the back of corrosive inflation in the early 1980s, has passed at age 92. He opened the door to longer expansions with lower inflation and lower interest rates. The sad part is that we failed to invest the proceeds of those good times in education and infrastructure. Volcker weathered death threats for his actions at the time, but helped to further establish how important it was to have an independent Federal Reserve. Politicians, seeking political over economic wins, had failed to stem corrosive inflationary pressures in the 1970s.
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