The three little words the Fed left out could be a big clue on where it’s going next
The U.S. Federal Reserve just cut its target interest rate for the third time this year. Let that sink in for a moment. Unemployment in the States is at or near five-decade lows. Economic growth isn’t anything to write home about, but it’s not bad: Q3 GDP numbers came in just hours before the Fed announcement Wednesday at 1.9-per-cent growth, which beat expectations by 30 basis points. Consumer spending is still strong, and it’s the biggest chunk of the U.S. economy. And yet the benchmark rate is still 75 bps lower than it was in June.
So let’s just note how remarkable that situation is, before allowing that the Wednesday cut was precisely what markets and economists expected. Fed-watchers have characterized this round of cutting as a “mid-cycle adjustment,” which implies that the central bank realizes it overshot as it raised rates from 2015 to 2018. Not that the Fed believes it has rounded down to a neutral rate — chair Jerome Powell made it clear in this comments on Wednesday that the 1.5-to-1.75-per-cent range for the federal funds rate is still accommodative. Again, just what the market wanted and expected to hear.
But now that we’ve been given pretty much what was expected, two questions: When will the Fed cut again? And when might it hike?
The answer to the first depends on how much the Fed thinks the world has changed since January, and how the various downside risks are building. Economic growth globally has slowed, and the U.S. economy has not been immune. While the American consumer continues to increase spending (but not by as much as in previous quarters, according to the Q3 data), the manufacturing sector and business investment have been hurting — a function of slowing growth and political/trade uncertainty. Inflation remains below the two-per-cent Fed target, a lingering fact of post-recession life that Powell has fretted about before. On the other hand, with a new election in the U.K. coming in December, some form of clarity might arise around Brexit; the Trump administration continues to talk up a potential (partial) deal with China on tariffs.
On the balance of risks, it looks like the Fed feels the downside still outweighs the upside, hence its still-accommodative stance. Notably, however, while the Federal Open Market Committee’s latest official statement is largely identical to its September statement, three little words are missing: “and will act.” Whereas in September the FOMC said it would monitor and act, this time around it says it will only monitor and assess. That implies a far more passive approach at least, and perhaps an end to any further cuts. Not surprisingly, market expectations for another cut in December plummeted following the statement’s release.
Sure, anything could happen, and the potential for a sharp decline in the Fed’s outlook in the short term remains. But clearly, Powell and his team think that the (new) accommodative rate is appropriate, for now, and another cut this year and potentially into next is less likely than it was before.
You have to wonder whether, should the economy slow further, lower rates would make that much difference. One of the realities of post-recession monetary policy seems to be that in a low-rate environment, the stimulative impact of cutting declines. (For evidence, look no further than Europe and Japan.) And the areas that are slowing most — manufacturing and business investment — seem to be particularly resistant to lower rates.
If the U.S. (or global) economy is indeed headed towards recession, it is doing so in a remarkably shambling fashion. If it ever gets there, there won’t be a lot of “steam” for a recession to take out, which raises the question of how much fuel it will take to get it moving again. Judging (again) from the experience of Europe and Japan, fiddling with rates might not be enough. Of course, monetary policymakers will do what they can do, and by taking a pause after Wednesday’s cut, the Fed is at least keeping powder dry if things get worse.
In some ways, the other question arising from the latest Fed announcement — when will it hike again? — is more significant in the long term, because the answer is basically never, or at least not in the foreseeable future.
It was clear from Powell’s comments that even should trade conflicts and other uncertainties get resolved, the Fed would be unlikely to contemplate reversing its recent cuts. About the only thing that would make it change course would be a “significant move up in inflation” — and there is absolutely no sign of that happening anytime soon. “Inflation keeps running below our key objectives,” Powell said. “Below-target inflation could lead to a long-term slide in inflation expectations.”
Unless you believe a sharp spike in inflation is inevitable — and Jerome Powell clearly doesn’t — the big takeaway from Wednesday’s cut is that the Fed isn’t approaching the floor; instead, it might have just established a new ceiling. Rates might stay the same for a while, they might go down, but they are almost certainly not going up.
So welcome to the new normal. It looks a lot like the old one, doesn’t it?