Questions Will Hang Over a No-Drama Fed Meeting

(Bloomberg Opinion) -- Data released last week measuring the U.S. economy ensured that, absent a major communication mishap, this week’s policy meeting of the Federal Reserve should end up being a no-drama nonevent for markets. That’s doubtless what Fed Chairman Jerome Powell and his colleagues on the Federal Open Market Committee desire. But it will leave for later meetings unsolved questions that have been highlighted by the latest economic numbers.

Friday’s initial reading for first-quarter growth came in at an impressive annual rate of 3.2 percent, significantly higher than the consensus estimate of just over 2 percent. It was also a remarkably long way away from predictions by some pessimists that the economy would actually shrink in January because of the month-long government shutdown that ended Jan. 25 and aftereffects of the market volatility that marked the fourth quarter of 2018.

Expectations that the surging gross domestic product would make the Fed rethink its first-quarter policy U-turn, in which it signaled that there will be no interest-rate hikes this year and that its balance-sheet reduction program will end in September, were immediately countered by two factors.

First, there were numbers embedded in the GDP report that raised doubts that 3 percent growth could be sustained. Potential one-off effects included the aftermath of companies having accelerated their imports to the prior quarter due to concerns about the possible intensification of tariffs on China. Inventory buildup also had an effect, adding to concerns from consumer-spending growth amounting to just 1.2 percent.

Second, the Fed’s preferred measure of inflation, the personal consumption expenditures price index, or PCE, came in at an annual rate of just 0.6 percent in the first quarter (with the core measure at 1.3 percent), well below the 2 percent target.

Add to those problems last week’s continued weak economic numbers out of Europe, and neither the composition of first-quarter GDP nor the price data suggest that the acceleration in what will soon be the longest economic expansion in U.S. history would be — or should be — viewed by Fed officials as constituting a need for altering monetary policy guidance.

But two questions linger that are likely to influence monetary policy, and the fate of the economy and financial markets, in the second half of this year and beyond:

• To what extent does persistently low inflation, especially in the context of technological change, suggest that monetary policy is less effective than it used to be? And if so, and thus stronger measures are needed to push inflation up, what is the mounting risk of unintended consequences and collateral damage in dogmatically pursuing the traditional 2 percent inflation target?
• If the underlying growth in nominal GDP is as low as indicated by first-quarter readings for PCE inflation and consumer spending, what are stock prices doing at record highs, and what does that mean for future financial stability?

These important questions will not be answered at this week’s Fed meeting. Instead, central bankers will hope to deliver a nonevent that puts distance between them and the dramatic market-moving policy U-turn of the last quarter, as well as keeping them off the radar screen of politicians.

To contact the editor responsible for this story: Jonathan Landman at jlandman4@bloomberg.net

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

Mohamed A. El-Erian is a Bloomberg Opinion columnist. He is the chief economic adviser at Allianz SE, the parent company of Pimco, where he served as CEO and co-CIO. His books include “The Only Game in Town” and “When Markets Collide.”

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