Beckner: Cautious FOMC Stays On Gradual Tightening Path After 6th Rate Hike

Written exclusively for InTouch Capital Markets

21st March 2018

– Still Projects Three 2018 Rate Hikes

– 2019-20 Rate Projections Up But Not By Much

– ‘Neutral’ Rate Moved up Just Slightly To 2.9%

– Powell Stresses Uncertainty of Outlook, Policy

By Steven K. Beckner

After all the anxiety leading up to the March 20-21 Federal Open Market Committee meeting, the Federal Reserve’s policymaking body’s interest rate actions and signals turned out to be underwhelming, not to say reassuring.

Contrary to Wall Street’s worst fears, the FOMC did not signal more aggressive interest rate hikes this year, despite revising up its economic projections, and it projected only modestly higher rates over subsequent years.

New Fed Chairman Powell and his colleagues could always change their perspective by the time they revise their rate expectations in June, but for now a mood of uncertainty and, hence, caution evidently prevailed at the first FOMC meeting chaired by Powell.

“The whole thing is very uncertain,” Powell told reporters after repeated questions about the impact of fiscal stimulus in his first press conference since taking over from Janet Yellen early last month. He also made clear recent trade tensions are much on the minds of policymakers.

As expected, the FOMC raised the federal funds rate, for the sixth time since leaving the zero lower bound in December 2015, to a 1.50% to 1.75% target range. The Board of Governors in turn lifted the interest rate on excess reserves to 1.75% and the primary credit (discount) rate to 2.25%.

The median funds rate projection of FOMC participants, including non-voting Federal Reserve Bank presidents, was left at 2.1% for 2018, implying just two more rate hikes this year instead of the additional three many had feared.

The total number of rate hikes for 2018 year was kept at three even though the officials raised thier GDP growth forecast from 2.5% to 2.7% and lowered their unemployment forecast from 3.9% to 3.8%. They further revised their forecasts for 2019, when they expect the unemployment rate to fall to 3.6%.

Another three rate hikes are foreseen in 2019, one more than projected in December, leaving the median funds rate at 2.9% — up from 2.7% in December. The median for the end of 2020 is 3.4%, up from 3.1% in December.

So over the next three years, the FOMC is projecting a net total of 30 basis points more in rate hikes — not a lot of additional tightening, considering officials’ rosier outlook for the next two years. But note they project growth to recede to 2.0% in 2020. And they expect inflation to stay tame, rising to 2.0% in 2019 and to 2.1% in 2020.

Powell made light of the upward revision to the 2020 funds rate median. “Remember these forecasts are three years out” and therefore “uncertain,” he said, adding the 3.4% median is only “modestly restrictive.”

Most of the focus has been on the funds rate “dots” for the rest of this year and the two following years. But just as significant is that FOMC participants increased their estimate of the “longer run” or “neutral” funds rate only slightly — from 2.8% to 2.9%.

Powell said “we see the neutral rate as still quite low,” although “we’re open to the possibility it will” move higher.

The meeting took place against a confusing backdrop. Tax cuts and increased federal spending made Powell and his colleagues more optimistic about economic growth, and labor force participation increased as jobs expanded more rapidly. Yet first quarter consumer spending and other data were disappointing. Wages and prices have increased only “moderately” as the beige book said and inflation, as measured by the Fed’s preferred PCE price gauge, remains stubbornly below the 2% target.

What’s more, the outlook is clouded by protectionist threats and counter-threats. Asked repeatedly about a possible trade war’s impact, Powell said, FOMC participants saw it as “a new risk that had been a low profile risk that has become a more prominent risk to the outlook.”

Then too, financial conditions have tightened considerably since the FOMC last met in late January, although Powell described them as still “accommodative.”

To achieve its employment and inflation goals, the Fed aims to calibrate overall financial conditions, including not just its administered rates but also what’s happening to market rates and asset values. The FOMC has to have observed that markets have done some of the needed tightening for it.

Ahead of the FOMC announcement, the Dow was off 7% from its January peak. The 10-year Treasury note yield is up 50 basis points since the start of the year. Dollar appreciation has also contributed to tighter financial condition lately, although the greenback remains lower than it was a year ago.

Increased volatility adds to the Fed’s sense of uncertainty.

So it should come as no great surprise that both the FOMC statement and Powell’s comments reflect caution. Despite the modest upward adjustments in rate projections in the out years, the new Fed chief exhibited little appetite for more aggressive rate action.

Although the statement echoed Powell’s late February Congressional testimony in saying “the economic outlook has strengthened,” in other respects it was less upbeat than the Jan. 31 statement. Instead of calling the pace of economic activity, household spending and business investment “solid,” the latest statement says “economic activity has been rising at a moderate rate” and notes household spending and business investment “have moderated.”

The FOMC reiterated risks to the outlook “appear roughly balanced.”

And Powell, who used the word “uncertain” again and again, was careful to say policy could go in either direction.

Asked about the possibility of more rate hikes, he said “like any set of forecasts, those forecasts will change over time…depending on how the economic outlook changes. They could change up or they could change down. It could be if the economy is a little stronger or a little weaker that the path could be a little less gradual or a little more gradual.

Lest we forget, in addition to its cumulative 150 basis points of rate hikes, the FOMC continues to tighten quantitatively through a prearranged passive shrinkage of the Fed’s balance sheet — reinvesting proceeds from a diminishing amount of securities FOMC is now directing the New York Fed’s open market trading desk to roll over principal payments from Treasury securities maturing each month only to the extent they exceed $12 billion — up from $6 billion in December. And it wants the Desk to reinvest proceeds of agency and agency mortgage-backed securities that exceed $8 billion per month — up from $4 billion in December.  Starting in April the caps will rise to $18 billion for Treasuries and $12 billion for MBS.