The last 2-day meeting of the FOMC signed an important change in monetary policy that affects the whole economy.
This is a clear sign of change from the Federal Reserve whose policies are being less restrictive and more careful about the situation of the economy.
What are the implications of this change and what are the perspectives for the near future?
A change in monetary policy
The Board of Governors of the Federal Reserve System voted unanimously to maintain unchanged the interest rate paid on required and excess reserve balances, that level is currently at 2.40%.
Contrary to 2018 declarations, this shows a lot more patience from the Federal Reserve on interest rates hikes. This is a result of economic indicators that show that in 2019, despite a strong labor market and low unemployment, growth of economic activity has slowed from its solid rate in the fourth quarter.
The position of the FED went from three interest rate hikes planned for 2019 to keeping interest rates unchanged, and this took place in a very short time period. Besides that, 11 governors declared that they don’t expect to make any rate hike for all 2019, during December 2018 meeting there were only 2 of the same opinion. Right now the expectation is for a single hike before the end of 2020.
This is a change in monetary policy that gives the FED more wiggle room in conducting monetary policy.
This means that there is less forward guidance from the FED, future decisions are more and more dependent on economics indicators and this translates in more uncertainty for all the economics operators.
Infinite Quantitative Easing?
The other bigger decision made by the FED in the last meeting was about the tapering program, the gradual winding down of all the assets purchased by the central bank during the Quantitative Easing in order to stimulate the economy. In order to fight the crisis, the FED acquired something like $ 4,000 billion worth of assets to boost economic growth, a kind of economic growth made possible by debt and free money, something that is definitely not sustainable over the long run.
In the last meeting the FED announced the early termination of the tapering: while the original plan provided for sales of securities from the central bank until mid 2020, now that date has been brought forward to September 2019 and they are also talking about a review starting from may.
This raises some questions about the entity of the securities sold by the FED to wind down its balance sheet since its beginning and the degree of fragility of the US economy in order to justify such a decision.
We might well see the QE extended indefinitely just to keep the situation as it is, not to mention a crisis scenario that we might see very soon.
State of the economy
As pointed out earlier, the analysis of the economy is of major importance for monetary policy because it is the driver of interest rates decisions. The slowing economy is what determined the shift of the central bank from raising interest rates to be more accommodating.
Right now, unemployment rate is at record low and reached a minimum of 3,7%. We have been in a 10-year long economic expansion and it is reasonable to expect a slowing down. Despite full employment, there isn’t any significant inflation pressure and as Jerome Powell pointed out when asked about future interest rates movements, the FED would like to see the need for interest rates hikes and a big part of this need is connected to inflation. The inflation is now at 1.90% (1.77% for core inflation) and it doesn’t look like a warning sign. By looking at inflation today, is unlikely to expect an increase in interest rates.
We should also look at the term spread in order to see what the expectations of the markets are.
The yield curve is flattening compared to previous years and it is this is another end-cycle economic indicator. Right now it is close to levels that in the past prompted the FED to cut interest rates.
The yield curve is actually a pretty accurate indicator of a coming crisis and if you look at other variables like debt and market valuations, you can conclude that, all things considered, we can reasonably expect a market crash and that could potentially turn very soon into an economic recession.
I am not the only one saying that, the Federal Reserve itself estimates a higher probability of recession, In fact, according to the February 2019 estimate by the Cleveland FED the probability of recession in 1 year is 29.7%!
What is the direction of the FED?
This is a key question, not only for the US markets but for the whole world economy. During the last year the Federal Reserve had a much stronger orientation towards a restrictive monetary policy. Now they gradually moved to a more dovish position saying that they are not going to rise interest rates and that future interest rates decisions are driven by economic indicators.
The last few FOMC meetings raised some uncertainty about the assessment of those economic indicators and the general orientation of the FED. Right now, there is not a strong monetary policy orientation, there are more and more uncertainties about the line of the central bank and so rising uncertainty among investors.
By considering the “dots”, or the estimates about interest rates made by FED governors, you get the indication of a single interest rates hike oh 0,25% in 2020 while the median is 2.625%,in line with the target of 2.50 – 2.75% while the long term neutral rate is considered 2.75%.
That information don’t constitute a real strategy of communication and they change from time to time, but they might be helpful to get a general idea about what is going on.
In a matter of months, the Federal Reserve went from being restrictive on monetary policy with a well defined path of interest rates hikes to a more accommodating position.
The expectations are for a single rate hike by 2020 instead of three that were still programmed in December, without any significant change for growth expectations, unemployment rate and inflation.
This is the result of looking at the economy and realising that it is weaker than expected and it is already slowing down by itself.
There is really no need for a series of interest rates hikes, given the high level of debt and extremely high market valuations, this could really damage the economy and be the catalyst of a financial crisis.
Monetary policy then is going to keep a much more cautious position by keeping interest rates at the current level and wait to see future developments in the economy.
Consequently, investors and market operators have less tools in order to understand and predict the central bank’s behaviour and it seems that the FED is mostly driven by events.
In this very complicated situation, the main message from the FED is that their intention is to support the american economy.
Are they going to stimulate the economy in the future “whatever it takes”?
I can’t say for sure, but I won’t be surprised if that happens.
This article is for informational purposes only, it should not be considered financial advice. You can read the full disclaimer here.