As was widely expected, the Fed raised the Federal Funds Rate 0.25%, bringing it to 2.5%. The press release shows a balance of demonstrating a willingness to ease the previously outlined path of interest rate hikes and a desire to avoid giving the unintended impression that they view the economy as weak.
Rather than stating today that there will be no rate hikes next year, their outlook changed from an expectation of 3 rate hikes to 2 potential rate hikes next year. In their statement, they said, "Information received since the Federal Open Market Committee met in November indicates that the 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, while growth of business fixed investment has moderated from its rapid pace earlier in the year.
The Fed is clearly aware of the potential impact from a slowdown in Capital Expenditures. The drop from the market's highs today after the Fed's press release suggests many investors don't believe the Fed's position on slowing the pace of future rate hikes was a strong enough statement. We believe they are missing the Fed's message. By reducing the number of expected rate hikes next year from 3 to 2, the Fed has essentially given itself more time to observe more data before making a decision to raise rates again. With the path of 3 rate hikes next year, it was widely expected that the Fed would be raising rates in the first quarter of 2019, however with only two expected increases next year, the Fed can easily hold off on any further action until June or July. This will allow time to observe wage growth, employment growth, consumer spending, capital expenditures, etc.
Additionally, the Fed said today "that risks to the economic outlook are roughly balanced, but they will continue to monitor global economic and financial developments and assess their implications for the economic outlook." The Fed is laying the groundwork to delay rate hikes in 2019 if either US or Global market conditions do not continue to accelerate.
They gave further clarity to their position saying, "In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its maximum employment objective and its symmetric 2 percent inflation objective."
We have heard the Fed reiterate over the last year that it is surprised we have not seen higher levels of inflation. We have also observed a lower wage growth than expected. Essentially, based on current data and the Fed's statement, they already have the argument in place not to raise rates again, unless and until they see higher inflation and higher wage growth.
Looking back to how the Fed communicates and operates, we thought it would be helpful to review their path to raising rates back in 2015. In Janet Yellen's press conference on March 18, 2015, she reaffirmed that the Fed had voted to maintain its target rate at 0 to 0.25%, but also said, "With continued improvements in economic conditions, however, we do not want to rule out the possibility that an increase in the target range could be warranted at subsequent meetings." To temper her statement, she said, "Let me emphasize, however, that the timing of the initial increase in the target range will depend on the Committee's assessment of incoming information." The Fed ultimately did raise interest rates, nine months later, at its December press conference. They allowed the idea to set in, and then over the remainder of the year, they provided the data points that would indicate to them the time had come.
We highlight this because we see the Fed's behavior in 2015 as being very similar to the Fed's behavior under Powell. The Fed shared the data it followed and it remarked on what the data meant in terms of the Fed's future actions. After reporting that the Fed's various targets had been achieved, it finally began raising rates.
Three weeks ago, as some global economic data started to show signs of slowing, Fed Chairman Powell commented that he though interest rates were "near neutral." The significance of neutral rates is that once rates are neutral, the Fed no longer needs to continue raising them. Then in today's press release, the Fed highlighted that they still continue to see a great deal of strength in the US economy, but that they did observe weakness in Capital Expenditures. To this observation, they added the that future rate increases would be dependent on the reaching of "expected" economic targets; some of which we know have not yet been met.
Powell is creating the path to either stop raising rates or to continue, should economic data justify the action. He is giving insight into what they are watching, and what they view positive and negative developments. At Powell's next press conference, we anticipate he will again report on the positive and negative data the Fed observes. If the data continues to weaken , we expect Powell to further reduce or delay future rate increases.
The way in which the Fed communicated today is healthy for the markets. Sudden and dramatic shifts in policy can undermine confidence in the markets, whereas consistent, thoughtful actions have proven to be beneficial to the market.
