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March 22, 2019

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Fed’s massage: no more rate cuts

The Federal Reserve has issued a stark message: The economy is slowing. And it won’t be raising interest rates any time soon.

The Fed left its key short-term rate unchanged on Wednesday and projected no rate hikes this year, reflecting a dimmer view of the economy as growth weakens in the United States and abroad.

The central bank said it was keeping its benchmark rate — which can influence everything from mortgages to credit cards to home equity lines of credit — in a range of 2.25 percent to 2.5 percent. It also announced that by September, it will no longer reduce its bond portfolio, a change intended to help keep long-term loan rates down.

Combined, the moves signal no major increases in borrowing rates for consumers and businesses. And together with the Fed’s dimmer forecast for growth this year — 2.1 percent, down from a previous projection of 2.3 percent — the statement it issued after its latest policy meeting suggests it’s grown more concerned about the economy. What’s more, with inflation remaining mild, the Fed feels no pressure to tighten credit.

In predicting no rate increases for 2019, the Fed’s policy-makers reduced their forecast from two that were previously predicted in December. They now project one rate hike in 2020 and none in 2021. The Fed had raised rates four times last year and a total of nine times since 2015.

The central bank’s theme, in its statement and in a news conference by Chairman Jerome Powell, is that it will remain continually “patient” about pursuing any further rate hikes.

Stock market indexes initially rallied on the news, but the gains soon faded and many stocks finished the day down.

Analysts said the Fed’s downgraded outlook for the economy might have alarmed investors.

“We think the Fed’s forecasts are still too upbeat,” said Michael Pearce, senior US economist at Capital Economics, saying he thinks sluggish growth will lead the Fed to start cutting rates early next year.

The Fed’s decision was approved on an 11-0 vote.

Stock prices have been generally surging since early January, when Powell abruptly reversed course and made clear that the Fed was in no hurry to raise rates and would likely slow the runoff from its balance sheet.

And while stocks struggled on Wednesday, the Fed’s plans for no credit tightening this year sent Treasury yields tumbling, with the 10-year yield touching its lowest level in more than a year. The yield reached 2.53 percent, down from 2.61 percent late Tuesday and 3.2 percent late last year.

The Fed’s policy-makers have clearly settled on the belief that more than a decade after they cut their benchmark rate to a record low near zero — and kept it there for seven years — that rate has now reached what’s called “neutral” — neither stimulating nor restraining economic growth.

The central bank’s pause in credit tightening is a response, in part, to slowdowns in the US and global economies. It says that while the job market remains strong, “growth of economic activity has slowed from its solid rate in the fourth quarter.”

A great time for patience

Some Fed watchers have said they think the next rate move could be a cut later this year if the economy slows as much as some fear it might. But at his news conference, Powell played down that prospect.

“It is a great time for us to be patient and to watch and wait,” Powell said, invoking the theme he has sounded in recent months.

The Fed spelled out a plan for stemming the reduction of its balance sheet: In May, it will slow its monthly reductions in Treasurys from US$30 billion to US$15 billion and end the run-off altogether in September. Starting in October, the Fed will shift its runoff of mortgage bonds into Treasuries so its overall balance sheet won’t drop further.

The central bank had aggressively bought mortgage and Treasury bonds after the 2008 financial crisis to help cut borrowing rates, spur lending and stimulate growth. With the economy now much stronger, the Fed has been gradually shrinking its bond portfolio. But now it’s prepared to slow and then stop that process to avoid putting upward pressure on loan rates.

The Fed’s new embrace of patience and flexibility reflects its response since the start of the year to slow growth at home and abroad, a nervous stock market and persistently mild inflation. The Fed executed an abrupt pivot when it met in January by signaling that it no longer expected to raise rates anytime soon.

The shift toward a more hands-off Fed and away from a policy of steadily tightening credit suggests that the policy-makers recognize that they went too far after they met in December. At that meeting, the Fed approved its fourth rate hike for 2018 and projected two additional rate increases in 2019. Powell also said he thought the balance sheet reduction would be on “automatic pilot.”

That message spooked investors, who worried about the prospect of steadily higher borrowing rates for consumers and businesses and perhaps a further economic slowdown. The stock market had begun falling in early October and then accelerated after the Fed’s December meeting.

President Donald Trump, injecting himself not for the first time into the Fed’s ostensibly independent deliberations, made clear he wasn’t happy, calling the December rate hike wrong-headed. But after the December turmoil, the Fed in January began sending a more comforting message. At an economic conference soon after New Year’s, Powell stressed that the Fed would be “flexible” and “patient” in raising rates.

Powell, on CBS’ 60 Minutes last week, denied that pressure from Trump had influenced the Fed’s policy shift. Most economists agree that a slowing economy and a sinking stock market, which eased Fed worries about any possible stock bubble, were decisive factors.




 

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