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Powell, Fed Colleagues Stress March Pause Amid Strategy Rethink

(Bloomberg) -- The policy shift under way at the Federal Reserve will affect new forecasts to be published later this month and also their longer-run strategy.

Recent remarks by Chairman Jerome Powell, Vice Chairman Richard Clarida, Governor Lael Brainard and New York Fed President John Williams have all signaled their contentment with letting the policy rate rest at 2.25 percent to 2.5 percent when they meet March 19-20, and perhaps for a few meetings after that.

Powell, Fed Colleagues Stress March Pause Amid Strategy Rethink

“With nothing in the outlook demanding an immediate policy response, and particularly given muted inflation pressures, the committee has adopted a patient, wait-and-see approach to considering any alteration in the stance of policy,’’ Powell said in the text of his remarks to the Stanford Institute of Economic Policy Research on Friday.

The March pause -- fully priced into futures markets -- is happening at a time when the U.S. economy is close to full employment and the Fed’s 2 percent inflation goal. Even so, Fed officials have cited risks to their forecast, including slowing global growth and domestic and international policy uncertainty with events like Brexit looming, as a good reason to watch and wait for a while.

‘Downside Risks’

“Heightened downside risks to output and employment would argue for a softer federal funds rate path even if the modal outlook for the economy were unchanged,” Brainard said in a speech Thursday.

But Fed officials also say inflation in this business cycle is more subdued, so that their policy response can be even more measured. Beyond that is the realization that low inflation and low interest rates may be a permanent feature in advanced economies now, leaving central banks too close the zero boundary on interest rates where policy is less potent.

Powell, Fed Colleagues Stress March Pause Amid Strategy Rethink

“We have to take seriously this problem of the lower bound and the fact that we’re so close to zero, even when rates are at neutral,’’ Powell said in a question-and-answer session following his remarks on Friday.

“Neutral’’ is a reference to the estimated policy rate setting that neither speeds up nor slows economic growth. Fed officials say they’re close to that level now.

“This is a problem for central banks around the world,’’ Powell added. “And all of the experiences we have to date of economies that go to the zero lower bound involve long periods of low inflation and low growth, so we need to try to find a better approach to that.’’

Strategy Review

That could be roughly translated to: the Fed wants to do its part to avoid an economy stuck in a lasting phase of low growth, low inflation, with a high debt-to-GDP ratio -- much like Japan.

Powell has asked the Fed to conduct a full-scale strategy review. The chairman, vice chairman, Brainard and Williams have all cited so-called make-up strategies as an area of interest. One idea is to aim for an average inflation target: for example, letting price indexes run above 2 percent for awhile to make up for past undershoots. The Fed’s having this conversation in the open, and investors are pondering how it will change the way they allocate money to markets. After all, the Fed’s preferred inflation barometer has spent more time under 2 percent in this expansion than over it.

“What does to mean to be living in a world where the most important central bank in the world is actively trying to raise inflation?’’ said Mark Spindel, chief investment officer at Potomac River Capital in Washington. “Buy more house,” he joked, because the financial stability concerns around a run-it-hot strategy are real. Even Powell, in his Stanford remarks, warned that make-up strategies are “largely untried,” and said “we have reason to question how they would perform in practice.”

Less Than Three?

For the rate path and forecasts to be released at the March meeting, the Fed’s strategic shift might mean this: the arc of the federal funds rate will be lower, and instead of three more hikes through 2021 there’ll be something less.

What’s more, if the strategy is shifting to a bias toward firmer inflation, the need to go above their the neutral rate -- which they estimated at 2.8 percent in December -- is less urgent. Fed officials penciled in a slightly restrictive rate in 2020 and 2021 at their last forecast round in December.

‘Room to Run’

If Fed officials “want to give the economy room to run with inflation above 2 percent, there is no reason to go above neutral,’’ said Priya Misra, head of global rates strategy at TD Securities in New York.

The Fed’s shift in policy bias and firming grasp of how profoundly different the post-crisis expansion is versus its predecessors is nothing short of historic. As a result, the old paradigm of a central bank that must “lean against the wind,’’ or “take away the punch bowl’’ is on its way to retirement. For experienced inflation fighters, such as former Fed Governor Laurence Meyer, it’s “a fascinating period.”

“Policy has to be different in the context of the zero bound. You have to tighten less and be very preemptive in lowering the funds rate toward zero’’ if the economy slows, said Meyer, president of Monetary Policy Analytics in Washington. “They always have priorities, and their priority is protecting the expansion.”

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