Fed: As Dovish As It Gets

Published on March 25, 2019

There is no question the Federal Open Market Committee delivered a spectacularly dovish policy outlook today. And we would be less than sincere if we didn’t add that we are somewhat taken aback by just how dovish Fed Chairman Jerome Powell seems to have pushed his FOMC since December’s “dovish hike” and “auto pilot” balance sheet.

*** No one asked, but we suspect Chairman Powell would have and probably should have acknowledged today’s hardening of “patience” is, in effect, an admission of a policy error in December’s rate hike. Offsetting any damage done in December to the economy is about the only credible explanation we can think of for the dramatic downshifting in rates to zero moves. ***

*** And not only did eleven of 17 FOMC members mark zero moves in 2019, but seven and five Committee members penciled in no rate hikes (or cuts) in 2020 and 2021 respectively, a remarkable three full year run to 2022 with no rate moves at all. It is left to ask what the economy, and inflation, would have looked like without the Fed “easing” into a still growing economy with no rate increases to even stay at a short run neutral rate. ***

A few observations about today’s trifecta of the policy statement, the Summary of Economic Projections/rate dot plot, and Chairman Powell’s terse, 45 minutes and done remarks to the press:

An Understated Statement

The statement itself, which is to be the primary vehicle to lay out the Fed’s policy stance, was in fact as bland as it could possibly be save for a repeat of the “patience” sentence, with a bare minimum of modest changes in the descriptive first paragraph of the economy. 

A fast read of the statement would have offered little hint to the sharp pivot to flatlining rates moves for three years by so many FOMC members. If there were no Summary of Economic Projections at this meeting, would there have been any indication of such a sharply slowing growth or the flattening of the rate trajectory? 

Dumping Those Celestial Stars

There were also some seemingly inconsistent aspects to the Summary of Economic Projections that can only be squared up if the “celestial stars’ of the estimated longer trend growth, unemployment, and neutral policy rates are all stripped out of the SEPs.

Median growth, for instance, was marked down to 2.1% from 2.3% — we assume pulled down by a soft first quarter — but trend growth was unchanged at 1.9%, meaning the slower growth is still running above trend; but median unemployment was, surprisingly, marked up (not down) to 3.7% from 3.5%, but which is still well under even the lowered estimates for longer run unemployment that was marked to 4.3% from 4.4%.

And while Chairman Powell asserted three different times the Fed sees no need for rate moves in either direction — i.e., is at a neutral policy stance — at the same time there was no change in the 2.8% median estimate for the longer run neutral. 

So unless the R* estimates are truly tossed aside, that would still be putting the current 2.4% effective policy rate “a long way” from neutral after all; instead, it suggests the Fed has concluded that only by extending accommodation will it be able to stem core PCE projections from slipping below 2%. 

An Accelerated End to Balance Sheet Run-off

And finally, on the balance sheet, we will leave a detailed look to others, but as we expected, Chairman Powell and the Committee were more than keen to wrap up the balance sheet policy as quickly as possible to get it out of the market speculation. The balance sheet run-off will indeed end in September, with October being the first full month of the new stabilized balance sheet at a bit above $3.5 trillion or 17% of GDP by year-end. 

Excess reserves will continue to be extinguished after October as currency in circulation and other liabilities rise with a still growing economy to allow for an eventual equilibrium in the reserve demand curve to be achieved without excessive volatility.

The surprise on the balance sheet was the taper starting in May through the end of September that will slow the asset run-off and leave the reserve balance and total balance sheet a bit higher than it would otherwise have been with a hard stop in the fall. 

So for those in the market who insisted the balance sheet reduction was a tightening in draining liquidity and hurting risk assets, the faster end to the balance sheet saga was a dovish bonus. 

A Lonely Bullard No More

We have written extensively over the last year about how the unexpected persistence in low inflation and the gnawing internal doubts over the usefulness of the labor slack-based Phillips Curve as the primary driver to inflation formation in the forecasting models was transforming the Fed’s assumptions on inflation dynamics. 

We had been assuming it would still take some time for the staff and forecasting processes across the Districts and Board to catch up with the FOMC’s policy pivot in January. But apparently not.

Today instead marked what could be a major movement, if not capitulation, inside the Fed to more fully embracing the policy narrative and assumptions long argued by Federal Reserve Bank President James Bullard as well as the broader secular stagnation thesis of former Treasury Secretary Lawrence Summers. 

We also suspect the influence of Vice Chairman Richard Clarida is in the ascendancy, in that the SEPs would seem to reflect his arguments for a very “muted” inflation outlook. 

Whether the slower growth will play out this year as mapped out in the new forecast, and especially whether the newfound uber rate dovishness will withstand the flow of data over the coming months remains to be seen. We are also, frankly, a little surprised by Chairman Powell’s blithely delivered assurance of no financial instability risks on the horizon – despite the backdrop of zero rate hikes for as far as the eye can see. 

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