As the Fed Angles for a Soft Landing, Expect a 'Dovish Hold’

(Bloomberg Opinion) -- With the economy continuing to defy predictions of recession, the Federal Reserve has good reason to take a victory lap at this week’s policy meeting. The latest jobs report adds to the evidence that after a rocky end to last year, the central bank’s dovish pivot positioned the economy to achieve the fabled “soft landing.”

Last December, the Fed hiked rates for the fourth time in 2018 despite very obvious turmoil in financial markets and growing signs of decelerating economic activity. If the rate hike itself was, charitably speaking, ill-advised, the accompanying forecasts announcing the expectation of further rate hikes in 2019 were completely out of touch with reality.  Fed Chair Jerome Powell, however, quickly pivoted in response to the growing market gloom, saying just a few weeks after the December rate hike that the Fed “will be prepared to adjust policy quickly and flexibly and to use all of our tools to support the economy” as deemed necessary.

By now, we know what followed. The Fed — under pressure from weak data, an inverted yield curve, and trade-policy uncertainty —  shifted in an increasingly dovish direction throughout the year. The policy shift culminated with a third rate cut in October that sent benchmark rates 75 basis points lower than were they had been a year earlier and, amazingly, 125 basis points below what the Fed had envisioned at the end of last year.

Powell has repeatedly said that the central bank’s timely shift toward easier policy helped the economy absorb this year’s negative shocks. Increasingly, it looks like he is right. The yield curve un-inverted, lower interest rates boosted housing, the consumer held strong, and, if you fancy the Markit PMI indicator, there are even signs that the beleaguered manufacturing sector is stabilizing. By all appearances, central bankers seem to have managed the trick of guiding the economy into a soft landing. If conditions hold,  the current episode will look very similar to the Fed-directed soft landing in 1995

The November employment report further supports the soft-landing hypothesis. Although the headline gain of 266,000 employees received a boost from 41,000 autoworkers returning from the strike at General Motors Co., this just mirrored a loss of autoworkers the previous month. The average job gain over the past three months is an undeniably healthy 205,000.

That job growth, combined with wage growth greater than 3% over the past year, will provide continued support for consumer spending. Lost in the excitement over Friday’s employment report was the University of Michigan’s preliminary release of its monthly gauge of consumer sentiment, which climbed to a seven-month high in December. Buying conditions for household durables and vehicles were both higher. Reports of the demise of the American consumer still look premature.

With the economy apparently on firmer footing, the Fed has the go-ahead to take a pause, following through with their October decision to hold rates steady absent a material change in the outlook. I don’t anticipate much if any change in the guidance.

Policy makers aren’t inclined to cut rates again barring a fresh downturn in activity; clearly, an upswing will take a rate cut off the table entirely. As for the prospect of reversing the rate cuts, the Fed isn’t ready to go there, either. Not only do central bankers remain wary of potential downside risk, they also have yet to achieve sustained inflation at their 2% target rate. (Note, along with rising consumer sentiment, the University of Michigan report also revealed that long-term inflation expectations fell back to their historical low). Powell will likely emphasize this point in the post-meeting press conference.

I guess, then, if we have to put a label on this meeting, it would be “dovish hold.” The Fed may be optimistic about the economy, but Powell and his colleagues don’t want to undermine their efforts this year with a premature pivot back to rate hikes. This will keep them standing pat. Having killed last year’s recession calls, the Fed can enjoy a well-deserved break.

To contact the editor responsible for this story: Beth Williams at bewilliams@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Tim Duy is a professor of practice and senior director of the Oregon Economic Forum at the University of Oregon and the author of Tim Duy's Fed Watch.

©2019 Bloomberg L.P.