Fed: Throwing in the Towel

Published on January 30, 2019

If the markets were looking for a pliant Federal Reserve this afternoon, they got everything they could have possibly wanted and more.

A few points to make:

** Any remaining hawkish holdouts on the Committee were brushed aside in the dovish revisions to the policy statement that strongly indicated policy is now at neutral. Notably citing “muted inflation,” the Committee without dissents affirmed they would be “patient” on “what future adjustments” may be appropriate, effectively opening the door to probabilities for a rate cut as much as the well-advertised pause, much less a hike. Indeed, despite describing an economy “rising at a solid rate” and a labor market that “continued to strengthen,” the bar to further rate hikes is now extremely high.

** The FOMC also issued a stand-alone “Statement Regarding Monetary Policy Implementation and Balance Sheet Normalization” that was perhaps even more dovish on several fronts: it referred to “ample reserves,” for instance, hinting at a larger balance sheet and by default, a sooner than previously indicated end to the balance sheet run-off; and the Committee also indicated a more policy-driven “flexibility” by being “prepared to adjust” the balance sheet “in light of economic and financial developments” that seemed to confirm the door is opening to a taper or “slowing” in the current pace of assets being run-off.

** And while he was careful to reaffirm the future policy path will be data-dependent, Chairman Jerome Powell did little in his press conference to push back against any of the dovish readings to the new Fed policy stance. Indeed the Dow was ripping higher by nearly 500 points as he spoke, yet he was seemingly a little less confident and perhaps a bit more defensive than would be ideal in the first of the press conferences after every meeting, especially in responding to the predictable and repeated questions about a “Powell Put” or “caving” to President Trump.

** We suspect in fact the “muted inflation” that made its way into the formal statement is more likely the crucial driver to the Fed’s more dovish near term policy stance. The internal debate over inflation dynamics has been a persistent theme running across the FOMC deliberations in recent years. The modest dip in inflation these last few months were more or less still within the confidence bands of the Fed’s inflation projections, but it may be the internal assessments are now turning towards an inertial inflation trending sideways that may now be at risk of ebbing just as it finally reached the 2% inflation target.

** If that proves to be the case — and we are not entirely certain but suspect it to be the case — it would be an indication of just how much the Committee consensus is moving away from the traditional Phillips Curve trade-offs as the paramount driver in the inflation process. In its place, there would seem to be a fuller embrace of a low inflation regime, driven primarily by anchored inflation expectations. If so, it would be a seminal internal shift similar in importance to the downgrade in the estimates for the longer run neutral that reshaped the rate dot plots and rate expectations in 2015 and 2016, even as the data and forecasts in both instances were largely unchanged.

** And relative to that backstory, we would add we were a bit surprised Chairman Powell did not adopt a more positive policy narrative to the Fed’s more dovish policy stance, that the muted inflation was for now affording the Fed a rare opportunity to probe a “high pressure economy” to test the limits for a higher labor participation, higher wages, and stronger productivity-enhancing investments. We would wonder whether that could become a policy messaging stance going forward.

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