Fed Expects No Rate Hikes and A September End to Balance Sheet Roll-off in Notably Dovish Decision
by Craig Dismuke, Dudley Carter
As expected, Federal Reserve officials left the target range at 2.25% to 2.50%, lowered their expected forward path for the Fed Funds, softened the Statement’s assessment of economic activity and overall inflation, and announced an end date to the current balance sheet normalization. However, the degree of the shift was exceptionally dovish.
In the updated Statement, officials acknowledged that “growth of economic activity has slowed from its solid rate in the fourth quarter.” In January, they said growth had been “rising at a solid rate.” February’s disappointing payroll report was acknowledged but the Fed continued to describe the labor market as “strong.” As expected, household spending was lumped in with business investment as experiencing “slower growth…in the first quarter.” The language on inflation blamed energy prices for overall inflation’s decline, but core inflation “remains near 2 percent.” The decision was unanimous.
The updated rate projections clearly responded to the slower growth assessment. The median Fed official now expects no rate increases in 2019, down from December’s expectation for two rate increases and an even greater concession from the three hikes penciled into last September’s forecast. For the 2019 dot to fall to no rate hikes for the rest of the year, four officials needed to remove one hike from their forecast while three others needed to remove at least two. In fact, 11 officials coalesced around March’s call for leaving rates unchanged for all of 2019. One rate hike is still expected in 2020, placing the terminal Fed Funds range at 2.50% to 2.75%, and the longer run neutral estimate held at 2.75%.
In the updated economic projections, the median growth estimate for 2019 was dropped 0.2% to 2.1% and for 2020 was lowered by 0.1% to 1.9%. The Fed continued to believe the economy’s longer run growth potential to be 1.9%. Less growth in turn means less downward pressure on unemployment, with 2019 and 2020’s unemployment rate estimates nudged up 0.2% to 3.7% and 3.8%, respectively. The estimate for 2021 was also increased by 0.1% to 3.9% while the natural rate was dropped 0.1% to 4.3%. Despite an energy drag on headline inflation expectations, the outlook for core PCE inflation was kept flat at 2.0% through 2021.
The other topic of interest, outside of Chair Powell’s press conference remarks, was any update on the balance sheet normalization process. In a separate release alongside the Statement, the Fed announced it will lower the cap on Treasury roll-off from $30B to $15B in May and conclude the reduction of its portfolio at the end of September. Starting in October, the first $20B of cash receipts from its agency-related portfolio holdings will be reinvested into Treasurys, with any in excess of that threshold reinvested back into agency mortgage backed securities. The current maturity composition of the portfolio will be used as a guide for reinvestments with continued future conversations planned to determine the ultimate structure of its holdings.
Bottom Line: The market response reflects how extremely dovish the tone in the Fed’s Statement, updated projections, and balance sheet announcement truly was. The Dow surged nearly 200 points from its lows, Treasury yield tumbled (2s -7.0 bps to 2.40%, 10s -7.4 bps to 2.54%), Fed Funds futures flattened sharply to price in a 50% chance of a cut by January, and the Dollar sank to a seven-week low. The Fed’s recent language has signaled they would remain patient in determining their next move to allow for more clarity on the outlook amid increased uncertainties (e.g. slower global and domestic growth, U.S.-China trade negotiations, Brexit, lagged effects of prior tightening). The March decision exceeded the market’s expectation in backing that up and addresses a major area of concern, that of a monetary policy error, for investors.
FOMC Official Statement
March 20, 2019
Information received since the Federal Open Market Committee met in January indicates that the labor market remains strong but that growth of economic activity has slowed from its solid rate in the fourth quarter. Payroll employment was little changed in February, but job gains have been solid, on average, in recent months, and the unemployment rate has remained low. Recent indicators point to slower growth of household spending and business fixed investment in the first quarter. On a 12-month basis, overall inflation has declined, largely as a result of lower energy prices; inflation for items other than food and energy remains near 2 percent. On balance, market-based measures of inflation compensation have remained low in recent months, and survey-based measures of longer-term inflation expectations are little changed.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. In support of these goals, the Committee decided to maintain the target range for the federal funds rate at 2-1/4 to 2-1/2 percent. The Committee continues to view sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective as the most likely outcomes. In 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 to support these outcomes.
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. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.
Voting for the FOMC monetary policy action were: Jerome H. Powell, Chairman; John C. Williams, Vice Chairman; Michelle W. Bowman; Lael Brainard; James Bullard; Richard H. Clarida; Charles L. Evans; Esther L. George; Randal K. Quarles; and Eric S. Rosengren.