January 29,30, 2019 FOMC Meeting

In a Nutshell:  â€œIn light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate…”

Decision: Fed funds rate target range remains at 2.25% to 2.50%.

The Fed has decided that it no longer has to do anything.  No, it hasn’t declared victory, but it has capitulated to the will of the markets and the reality of a slowing world economy.  The members, and especially Chair Powell, will sharply disagree with that characterization, but basically, the FOMC gave the markets everything it hoped for: No rate hike, a clear indication that conditions would have to change for the Fed to hike rates again and a willingness to slow the normalization of the balance sheet.  All this came after having indicated just four months ago that the Fed was a “long way” from getting to neutral.  Since then there has been exactly one rate hike, which is hardly a long way.

So, what has changed?  First, the tariff/trade war with China has harmed not just Chinese growth but the world economy as well.  Europe is suffering and U.S. economic growth is moderating.  When the three largest economies are in a slowdown, it is time to stop, look and listen.  Then there was the market meltdown.  First, the culprit was the Fed raising rates too much, but that made absolutely no sense.  Rates are still low, unless you think zero interest rates are normal.  Then the Fed’s reduction of the balance sheet was attacked, since it was reducing liquidity.  But the Fed’s balance sheet is still way too large, so that was a red herring.  Basically, investors wanted to blame everyone but themselves for the meltdown and they succeeded in pinning it on the Fed. 

So, where is the Fed now?  First, Mr. Powell, by saying the “case for raising interest rates has weakened somewhat”, basically changed the paradigm.  Now, the Fed has to see there is a reason to hike rates.  Mr. Powell indicated that inflation is likely to be the key.  So, as long as inflation remains well contained, the Fed is on hold.  That should anchor short-term rates at a lower level than expected.

As for the balance sheet, which is more technical but still important, the pace will continue, though it could be changed, and the end point will be a lot higher than expected.  The Fed will likely stop reducing the balance sheet, nicknamed quantitative tightening or QT, about a half trillion dollars above where previously expected.  That is about nine months sooner. 

The markets, not surprisingly, loved the FOMC statement and the Fed Chair’s press conference as they gave investors everything they wanted.  And there is good reason to show caution, as the outcome of the trade situation is still not clear.  But it sure looks like this Fed Chair may believe in a triple not dual mandate: Maximum employment, stable inflation and a solid equity market. 

 (The next FOMC meeting is March 19,20 2019.)