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Fed Moves to Sidelines

RFP
The Federal Open Market Committee (FOMC) held rates unchanged at its December meeting. Forecasts for 2020 were raised slightly, while the forecast for inflation was revised down slightly. The majority of participants expect no change in rates in 2020; a significant but shrinking minority of four expect one rate hike in 2020. No participants believe that the Fed could raise rates dramatically in 2020. This marks a sharp shift from September, the last time the Federal Reserve released its report, and suggests that recent rate cuts will be longer lasting.

The idea that this was a mid-cycle adjustment in rates like we saw in the late 1990s no longer holds; the cuts look much more permanent. The vote to hold rates unchanged was unanimous, the first time that all agreed on what the Fed should be doing since May 2019. The recent rate-cutting cycle began in July.

The FOMC statement and forecasts were more notable for what they lacked than what they included. Concerns about the risks associated with weakness abroad and trade wars were removed from the statement. The Fed also failed to further reduce its estimates of the neutral fed funds rate and the unemployment rate.

The Fed will continue to provide support for overnight credit markets into the first half of 2020. They have left the door open to additional increases in the balance sheet if needed. The Fed still doesn’t seem to have a permanent solution for the distortions we saw in the overnight market in September.

Chairman Powell tried to argue that the Fed still believes there is a link between unemployment and inflation, although one wouldn’t know it by looking at the Fed’s own forecasts. Powell said that the need for rate increases is less than it was in the past. The threshold to raise rates is still much higher than the threshold to cut rates going forward. Powell made it clear that he would need to see a sustained period of inflation before he raises rates. But, Powell is more dovish than many of his colleagues at the regional Federal Reserve Banks. He also underscored that full employment occurs at a much lower level of unemployment than the Fed has expected; he still sees some slack in the economy, which means we could see unemployment go lower than forecast before wages and inflation pick up in a meaningful way.

Bottom Line
The statement and forecasts were slightly more hawkish than one would expect, given their underlying forecasts for inflation and long-term unemployment. Members of the FOMC clearly believe that they are already being accommodative on the policy front. Our bet is that persistently low inflation will force the Fed to cut rates at least once again in 2020. Markets moved little on the news, which means that Powell succeeded in making this the most boring and uneventful meeting of the year. We have come a long way from last year, when the Fed added insult to injury in a market that was collapsing.

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