Fed Remains on Hold to the Surprise of Nobody

As widely expected, the Federal Open Market Committee (FOMC) decided today to keep its target range for the fed funds rate unchanged at 2.25% to 2.50% (top chart). There were no dissents among the 10 voting members of the committee. The decision to keep rates on hold had been widely expected by the market because most FOMC members had been indicating in recent public comments that the committee likely will be on hold for the foreseeable future as it watches incoming economic data.

Fed Can Be ‘Patient’

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Of more interest was the statement that the FOMC released today, which we interpret as generally dovish. For starters, the committee downgraded its assessment of the economy. In December, the FOMC said that ‘economic activity has been rising at a strong (emphasis ours) rate.’ It now characterizes the pace of growth as solid. Indeed, GDP growth slowed in the third quarter (middle chart), and we estimate that growth slowed further in the fourth quarter and forecast that growth will downshift further in the first quarter of 2019.

Additionally, the committee removed its forward guidance. Following previous meetings, the FOMC had judged that ‘some further gradual increases in the target range for the federal funds rate’ would be needed to ensure that the economic expansion remained sustainable without inflation overshooting the Fed’s two percent objective. Although the committee maintains that continued economic expansion is still ‘the most likely outcome,’ the FOMC removed the reference to further rate hikes. Furthermore, the committee said that it can be ‘patient’ (emphasis ours) as it determines what future adjustments to the target range for the federal funds rate may be appropriate.

Next Rate Move: Up or Down?

In short, the Fed is on hold for the foreseeable future. Indeed, the FOMC can afford to be patient because PCE inflation (the Fed’s preferred measure of consumer price inflation) is running at its target of 2% (bottom chart). So what is the next move for the fed funds rate? Will the Fed eventually hike rates again, or will it reverse course and cut rates? Or will it be on hold for an indefinite period of time?

In our view, another rate hike is the most likely outcome. We forecast that real GDP will grow at an annualized rate between 2.0% and 2.5% in coming quarters. If that forecast is reasonably close to being correct, then the unemployment rate, which is already near a 50-year low, likely will continue to trend lower, putting some upward pressure on wage inflation. We judge that the FOMC will opt to tap on the brakes again (i.e., raise rates by 25 bps) this summer and again at the end of the year. We then look for the Fed to remain on hold through much of 2020.

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