Deciphering the intentions of Federal Reserve officials rarely gets this easy. As one after another preaches patience before their next interest-rate move, a tougher question is emerging about their plans to pause: Is this a pit stop or the peak?
After nine rate increases since December 2015, Fed officials have shifted from signalling “gradual” tightening to a stance that is “patient,” a word chairman Jerome Powell used in comments January 10 that has been repeated by several of his colleagues since. The chorus even extended to Kansas City Fed President Esther George, usually one of the most hawkish members and one who votes on monetary policy this year.
Anticipating a Fed on hold, financial markets are pricing in a high probability of no change at all in the policy rate for 2019. US central bankers in December wrote down a median estimate of two more. Bridging this gap with investors is going to be tricky and potentially volatile if the Fed decides it needs to start raising rates again.
“The Fed’s hope is that the data will be pretty clear,” said Michael Gapen, chief US economist at Barclays Plc. “They will have to re-engage markets and tell them we are going to tighten a little further.”
Gapen and other economists, such as Omair Sharif at Societe Generale, are pushing their forecast for hikes into the back half of 2019 for a variety of reasons.
The government shutdown is going to make first-quarter data murky. Inflation is slightly below the Fed’s 2% target. Minutes from the December meeting show the policy committee pondering as many as five downside risks — from escalating trade tensions, to slowing global growth and tighter financial conditions in the US.
“Now is the perfect time to sit back,” Sharif said in an interview.
A pit stop: For the Fed, a patient posture means the economy will dictate if and when the central bank moves. Here are the arguments from both sides:
Nothing suggests that the strong US labour market has veered off its pace of job gains. The US economy added 2.6mn jobs last year and December finished with a gain of 312,000. That underpins household confidence and consumption, the most important engine for US growth.
Compensation measures are moving up gradually as companies offer more benefits and pay to retain and attract workers. If labour market strength continues at the same pace, some economists predict it will eventually show up in firmer prices that the Fed will have to lean against with more gradual rate hikes.
“The labour market is still tightening,” said Michael Feroli, chief US economist for JPMorgan Chase & Co “We think underlying wage pressures have been accelerating.”
Another part of the growth story for 2019 is fiscal stimulus. The spending boost from personal and corporate tax cuts is fading a bit, says Ryan Sweet, head of monetary policy research at Moody’s Analytics Inc. But the firm estimates that higher government spending could add as much as four tenths of a% to gross domestic product this year.
“I would be surprised if this is the peak of the tightening cycle,” Sweet said.
“Policy makers have been broadly unified in their call for a pause, regardless of bias on the hawk-dove spectrum. Differences in opinion remain with respect to the course of action over a longer time horizon. Bloomberg Economics projects there will be a need for a moderate amount of additional tightening to resume around mid-year as robust labour conditions meaningfully contribute to economic resilience,” Carl Riccadonna of Bloomberg Economics said.
The peak: One of the strongest cases for standing pat is the asymmetry of its policy risks, says Laurence Meyer, a former Fed governor and head of Monetary Policy Analytics Inc in Washington.
The Fed has consistently undershot its inflation target for most of the expansion. If actual growth, and Fed officials’ forecasts for next year, start to decelerate by June, Meyer said, the Federal Open Market Committee would be cautious about tightening further.
“We are in a dangerous place,” Meyer said. “You have some fragility now where a shock could make us fall into a recession with the policy constraint of the zero boundary” still too close.
Meyer has penciled in one more hike in June based on his firm’s view that labour market momentum continues. But he said it’s a close call.
“Even if the economy is growing at 2.5%, if you think it is on a slowing trend over the next year or two, why would you go?”
Constance Hunter, the chief economist at KPMG LLP in New York, said the risk of slowing global growth is the single most important issue in her rate-peak call. Hunter forecasts the Fed could begin cutting the policy rate by mid-year as Chinese consumption retrenches, and such a slowdown “will reverberate to all countries.”
She isn’t alone with such concerns.
Both Powell and Fed Vice Chairman Richard Clarida have said slowing global growth is a risk they’re watching as the American job market stays strong and domestic inflation shows little sign of flaring up.
“We begin the year as close to our assigned objectives as we have in a very long time,” Clarida said in a speech January 10. “In these circumstances, I believe patience is a virtue and is one we can today afford.”
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