Beckner: A Stronger Note Of Caution From the Fed

Written exclusively for InTouch Capital Markets

1st November 2018

By Steven K. Beckner

An unmistakable new mood of caution seems evident in recent Federal Reserve pronouncements.

Despite continued strong U.S. economic growth, we’ve been hearing elevated expressions of concern about financial turbulence, slowing global growth and trade tensions. Unless they intensify, those issues probably won’t divert the Fed’s policymaking Federal Open Market Committee from raising short-term interest rates at its Dec. 18-19 meeting. But worrisome “readings on financial and international developments” could alter 2019 rate projections.

This greater caution was foreseeable. Last Tuesday, I wrote, “If Fed policymakers determine those “financial and international developments’ are apt to adversely affect the outlook for GDP growth, employment and inflation, then it might make perfect sense for the FOMC to alter course…”

The next evening, while saying the U.S. economy is “in a good place,” Chairman Jerome Powell cited a number of risks to the outlook and stressed the need for the FOMC to proceed cautiously. In a live-streamed chat with Dallas Federal Reserve Bank President Robert Kaplan, Powell said he’s “very happy about the state of the economy now,” but enumerated concerns about:

* Trade: “you could see a little bit slower growth to the extent that more and more products are subject to tariff. You could see a little bit higher inflation and a little bit slower growth.”

* The global economy: After a solid 2017 and “a lot of optimism” in early 2018, “this year has seen a gradual chipping away at that picture. You’ve seen a bit of a slowdown — not a terrible slowdown. You still see solid growth, but you see kind of growing signs of a bit of a slowdown, and it is concerning….(W)hat happens (overseas) … really matters for us, and we watch it carefully.”

* Financial markets: The equity market is “a very high profile thing, and it does matter for the economy of course….(W)hen equity prices are high people are going to spend a little bit of that. … Typically, people would need to think that that increase in equity values is … sustained before they would spend much out of their wealth, but there is an effect. So when prices go down and are volatile we do pick up an effect, but it’s one of many, many factors in a very large economy…”

Powell also anticipated the stimulus of tax cuts and spending increases “is going to wear off over time” and that the “lagged effect of our interest rate increases” will have an impact.

None of these concerns signal a policy shift, but collectively they could prove significant if they persist.

Already, Powell implied, the FOMC must move more gingerly. Stressing the imprecision of concepts like the natural unemployment rate and the neutral interest rate and the need to avoid raising rates either too slowly or too rapidly, he said “we’re at point now where we have to take both of those risks very seriously, and that’s why we’ve been raising rates quite gradually.”

More colorfully, he said, “if you’re walking through a room full of `furniture and the lights go off, what do you do? You slow down. You stop probably and feel your way. So it’s not different with policy. When there’s much more uncertainty, in some cases you’re going to do less, and in some casesĀ  you’re going to want do more.”

Similarly “patient” utterances came the next day from Atlanta Fed President Raphael Bostic.

Bostic, who voted for three 2018 rate hikes, said “conditions warrant the final steps in removing any remaining accommodation and adopting a neutral stance of monetary policy.” But he appended a “complicated” question: “What, if any, further adjustments are necessary to get to neutral?”

“(J)ust as there are risks to too-timid policy adjustments, there are decidedly risks to policy adjustments that are too aggressive,” he went on. “The main uncertainty … is that it is very difficult to determine when the economy is actually overheating — especially when inflationary signals across the board remain subdued….”

Balancing those risks, Bostic could “think of no superior approach than to proceed cautiously and keep a keen eye on the data.”

Vice Chairman Richard Clarida said Friday the U.S. economy is “doing well,” but said the FOMC must pay attention to slowing global growth. He noted increased market volatility, although he took “no clear signal” from it.

“As you move in the range of policy that by some estimates is close to neutral, then with the economy doing well it’s appropriate to sort of shift the emphasis toward being more data dependent,” Clarida told CNBC, adding, “we need to be especially data-dependent.”

Meanwhile, the Fed Board announced it “will review the strategies, tools, and communication practices it uses to pursue its Congressionally assigned mandate of maximum employment and price stability” next year and sponsor a research conference next June at the Chicago Fed.

The unusual press release quoted Powell saying, “With labor market conditions close to maximum employment and inflation near our 2 percent objective, now is a good time to take stock of how we formulate, conduct, and communicate monetary policy.”

It was another straw in the wind, underscoring the need to proceed cautiously given many uncertainties. Powell seems to be saying he and his colleagues are unsure about the “normal” values of full employment and the neutral rate, so they must study them and make allowance for them. The implication is that, more than ever, the FOMC needs to proceed carefully lest it make unwarranted assumptions about whether the economy is overheating.