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December 21, 2018

Fed's Unanimous Front to Normalize Interest Rates

Under tremendous pressure, the Fed sticks to its guns, mostly, and the crybabies are having a cow.

The S&P 500 index plunged 3% in two hours from its intraday peak at 2 p.m., after the Fed announced its un-dovish decision that it’s not flip-flopping. The index ended the day down 1.5%. It’s now down 6.2% for the year.

The Federal Open Markets Committee (FOMC) voted to raise its target for the federal funds rate by a quarter point to a range between 2.25% and 2.5%. This was the fourth rate hike in 2018, and the ninth baby-step in this cycle that started so tentatively three years ago. It has been the slowest rate-hike cycle in history. The range is still historically low and is barely above the rate of inflation as measured by CPI (2.2%).

But from the clamoring on Wall Street and the White House, you’d think interest rates have been propelled into the stratosphere.

Unanimous:

Of the 10 FOMC members currently in voting slots, all 10 of them, unanimously, voted for the rate hike. This wasn’t a toss-up.

A “strong” economy needs normalized interest rates…

In terms of its assessment of the economy, the FOMC saw mostly strength. From statement:

[T]he labor market has continued to strengthen and that economic activity has been rising at a strong rate. Job gains have been strong, on average, in recent months, and the unemployment rate has remained low. Household spending has continued to grow strongly…
There was a cloud, as the impact of corporate tax cuts is fading: “growth of business fixed investment has moderated from its rapid pace earlier in the year.”

The FOMC sees stable inflation near the Fed’s target of 2%, as measured by core PCE (1.9%), which purposefully tracks lower than CPI.

Yes, “some” more rate hikes

In terms of future rate hikes, there is a minor downshift in language: a “some” got wedged into the phrase. And now “some further gradual increases” are on the table, instead of just “further gradual increases,” as in the statement of the last rate-hike meeting in September.

A piece of red meat for the crybabies

Some old language started to show up again: The Fed “will take into account a wide range of information,” including all the usual things plus: “readings on financial and international developments.”
This language is designed to show the crybabies on Wall Street, in the White House, at the IMF, etc., that the Fed is not deaf to the turmoil in the US financial markets, which are curdling, and the upheaval in emerging markets where governments and companies issued dollar-denominated debt while the getting was still good but now have trouble servicing this dollar-debt with their inflation-devalued local currencies.

A smaller increase for the banks

The Board of Governors also voted unanimously to hike by 20 basis points, rather than by 25 basis points, the interest rate the Fed pays the banks on required and excess reserve balances. At 2.40%, this rate is now 10 basis points lower than the top of the Fed’s target range for the federal funds rate. The Fed is raising this rate at a slower pace to keep a lid on the federal funds rate which has been bouncing into the upper limit of the target range.

“Neutral” edges down, becomes easier to reach

In another development, the median estimate among Committee members for the “neutral” interest rate fell to 2.75%, from 3% in the forecasts from the September meeting. In other words, if the Fed wants to lift rates slightly above neutral — as it still seems to do — it would need to raise rates only two more times. And a third rate hike would get it comfortably beyond neutral.

The QE Unwind continues as planned

The Committee stuck to its plan to unwind QE at a rate of up to $50 billion a month, despite all the clamoring from Wall Street and the White House that don’t want the drunken party to end. The Committee, as it always does, explained its decision and the mechanics to continue its balance sheet normalization it its Implementation Note.

Then in the press conference, Fed Chairman Jerome Powell, when asked about it, confirmed it:
“We thought carefully about this, how to normalize policy and came to the view that we’d effectively have the balance sheet run off on automatic pilot and use monetary policy — rate policy to adjust to incoming data. And I think that has been a good decision. I think that the runoff of the balance sheet has been smooth and has served its purpose, and I don’t see us changing that. And I do think that we will continue to use monetary policy, which is to say rate policy, as the active tool of monetary policy.”

And now it’s getting interesting…

The median projection by the FOMC members for the federal funds rate at the end of 2019 inched down to 2.9% (from 3.1% in September), which implies two more rate hikes in 2019, to a range between 2.75% and 3.0%. The median projection for 2020 inched down to 3.1%, implying an additional rate hike.

But here is the thing: A year ago, at the December 2017 meeting, the FOMC’s median projection for the federal funds rate at the end of 2018 was 2.1%. In other words, a year ago, they projected three rate hikes in 2018; and in 2018 they voted for four rate hikes — each time unanimously!

And the effective federal funds rate is around 2.4% as of tomorrow, not 2.1%, as projected a year ago.

In this light, the infamous dot plot of today’s meeting gets a new meaning. Of the 17 members (some of whom will not be able to vote next year):
  • 0 members see a rate cut in 2019
  • 2 members see no rate hikes in 2019
  • 4 members see one hike in 2019
  • 5 members see two hikes in 2019
  • 6 members see three rate hikes in 2019.
So six members see three rate hikes in 2019. That is more than the four members a year ago that saw the four rate hikes in 2018 that actually came to pass.

The remaining 12 members a year ago underestimated the rate hikes in 2018. Oh my, how they changed… and unanimously voted for four rate hikes. Today’s projections of two rate hikes in 2019 should be seen in light of last year’s projection of three hikes for 2018.

So this is not at all what the Wall Street crybabies, who’d thought wishfully that the Fed had suddenly turned super-dovish, had been dreaming about.

Powell has come under constant and withering attacks from the White House for finally doing what the Fed should have done years ago. In the press conference, he was asked if this political pressure plays a role in the Fed’s decisions. And this is how answered:
“Political considerations have played no role whatsoever in our discussions or decisions about monetary policy,” he said. “We’re always going to be focused on the mission that Congress has given us. We have the tools to carry it out, and we the independence which we think is essential to be able to do our jobs in a non-political way. And we at the Fed are absolutely committed to that mission, and nothing will deter us from doing what we think is the right thing to do.”


We’ll see. But so far, so good.  

Courtesy of Wolf Richter via Wolf Street (More from Wolf Street here)    

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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