Fed Puts Markets on Notice Over Its Needs for Rate Patience
(Bloomberg) -- The Federal Reserve’s top officials say the economy is in a good place and suggest further interest-rate increases will depend on incoming data easing concerns about risks to their outlook.
Comments in the last 72 hours by Chairman Jerome Powell and No. 2 Richard Clarida lay out clear lines of debate when the Federal Open Market Committee meets later this month.
“Their baseline outlook is solid, but the clear discussion is risks are skewed to the downside,’’ said Michael Hanson, chief U.S. macro strategist at TD Securities in New York.
Officials will release fresh quarterly forecasts at the March 19-20 FOMC meeting. What’s becoming clear is their outlook for U.S. growth could be downgraded and their December estimates for hiking twice in 2019 could get pared back.
Investors currently expect them to keep rates on hold all year, according to pricing in interest rate futures.
“Even relative to December, I would probably mark down” my forecast for global growth, Clarida told the National Association for Business Economics Thursday. Among officials’ top concerns are a cooling world expansion, somewhat tighter financial conditions, and policy uncertainty around trade disputes and Brexit.
The new buzzword on the Fed’s policy committee is “patient.” They used it in their January statement and the meaning has been further developed through speeches and two days of testimony by Powell before Congress this week.
What’s become clear is that Powell and Clarida are willing to let inflation measures tell them whether the Fed’s benchmark policy rate is too low or high, and they don’t have a strong conviction on whether it should still be heading higher.
“Their view on how close they are to restrictive territory will be dependent on how inflation evolves,’’ said Robert Martin, executive director at UBS Securities LLC in New York. “They want the data to teach them where they are.’’
The concept is so important, that Powell voluntarily reiterated it at the close of his hearing in the Senate on Tuesday -- just in case lawmakers didn’t hear him the first time.
“We’re going to be patient. What that really means is that we’re in no rush to make a judgment about changes in policy,’’ Powell told the Senate Banking Committee Chairman Mike Crapo. “We’re going to allow the situation to evolve.’’ The Fed chief reiterated that idea in a speech on Thursday evening in New York.
Whatever forecasts officials do make in March are surrounded by uncertainty. The same was true for their December projections, minutes of that meeting later revealed. But they fumbled the communication, spooked markets by sounding too committed to further rate hikes, and have engaged in a two-month speaking campaign to reverse the damage.
“It was a disastrous, circuitous route to get where they are, but they are happy they are there,” said Mark Spindel, head of Potomac River Capital and co-author of a book on the Fed, referring to the recent pause in rate hikes. “They really think they are in a great spot.’’
Another feature of the patience doctrine is that a policy of jumping ahead on rates based on a forecast of higher inflation, known internally as pre-emption, has been retired.
Clarida discussed how even if a model predicted a surge in inflation, that would have to be balanced “against the considerable cost’’ of that forecast being wrong. Commerce Department data released on Friday showed the Fed’s preferred price index rose 1.7 percent for the year ending December; excluding food and energy, the index rose 1.94 percent, just below their 2 percent goal.
“Given muted inflation and stable inflation expectations, I believe we can be patient and allow the data to flow in as we determine what future adjustments to the target range for the federal funds rate may be,” Clarida said.
Finally, the officials also gave some hints on how their balance sheet discussions are evolving. Powell said the Fed’s balance sheet could settle into a range of 16 percent to 17 percent of GDP compared with 6 percent before the financial crisis.
In today’s numbers, GDP currently stands at $20.9 trillion so by the Fed’s estimate a normalized balance sheet would be around $3.5 trillion. Total assets on the balance sheet are currently about $4 trillion.
“The committee can now decide on the appropriate timing and pace for concluding our balance sheet drawdown,” Clarida said, hinting that they may taper the runoff into their target range.
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