Fed: The Persistence in Low Inflation

Published on December 19, 2018

The single most important takeaway we drew from the Federal Open Market Committee’s policy decision today was an unexpected persistence in low inflation that must have colored the two days of discussions and, we suspect, nearly upended the Committee consensus.

That, we think, may explain the tone of Chairman Jerome Powell’s somewhat more nervously delivered answers to the press.

*** On balance, if there is a tilt to the FOMC policy stance going forward, we believe it is towards fewer rather than more rate hikes, if even two hikes in 2019. It will depend, as Chairman Powell tried to stress, on the incoming data and how it feeds into the forecast, especially for inflation. We continue to expect that it will probably translate into a “pause” in the quarterly pace of rate hikes that is more likely to fall in the first half rather than the second half of next year. ***

A few other points of reference:

** First, we would be remiss not to note that the outcome of the decision, statement and the SEPs were all neatly in line with our expectations: a hike in the target range to 2.25%-2.5%, the IOER to 2.4%, the 2018 median rate dots at two down from three projected hikes, a flattened trajectory of rate increases across 2021, NAIRU nudged lower, a somewhat surprisingly slight nudge up in trend growth and, as Chairman Powell affirmed, no plans for a change in the balance sheet run-off (SGH 12/18/18, “Fed: December Expectations”). ***

** Chairman Powell did his best to remind everyone, perhaps including his hawkish colleagues, in repeating what must have been a half dozen times that “there is significant uncertainty about both the path and the ultimate destination of any further rate increases.” But he failed in the process to provide much context to what was an intended messaging about a wider variance around the base case rate path.

** We suspect the somewhat muddled messaging reflected the difficulty in straddling a split within the FOMC that seemed evident to us in the statement: the more hawkish Committee members may have insisted the “gradual increases” language remain in the statement to signal policy is still on a tightening path. But a compromise with the more dovish leaning members got the phrasing softened with the “some” qualifier, as well as a slightly more conditional “judges” rather than “expects” to preface the guidance.

** We would stress that the Fed’s dovish lean we took away from the afternoon is not driven by shaky, volatile stock markets and certainly not the missives from the White House. But rather, the conundrum splitting the Committee at present is all about the unexpected persistence in a still inertial, low inflation that we previously highlighted (see SGH 12/10/18, “Fed: December and When To Pause”).

** Indeed, despite the record late cycle fiscal stimulus to demand and what Powell noted was the best year for the economy since the crisis, yet inflation will now come under target this year for the seventh year in a row, and gone altogether is any of the modest overshoot previously forecast. What will happen to underlying inflation if growth and demand does indeed slow? But Powell never did provide a satisfactory answer or explanation for that in his presser.

** It also points to a neutral rate that is closer to 2.5% than 3% in that “broad range of estimates Powell cited in his ECONY speech, and that the median longer run estimate of neutral came down to 2.75% after having been nudged up to 3% from 2.9% in September is indicative of those growing views.

** We suspect this will give something of an upper hand to the two lonely Midwestern doves on the Committee, especially if inflation fails to show upward more momentum through the first half of next year. It will certainly add fuel to the debate during Vice Chairman Richard Clarida’s subcommittee review of assumptions going into the policy framework.

** We had also suggested that Chairman Powell’s honeymoon period with his less detailed, easy answers to a respectful press could come to an end with the December meeting. The confusion in the markets would seem to confirm that; groping in the dark barefoot is just not the optimal metaphor for Fed policy going forward. And what’s more, the tweets and attacks from the White House will no doubt get worse from here.

In other words, welcome to the NFL, Chairman Powell.

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