New year, new Fed

A lot has changed in six weeks. After the previous meeting of the rate-setting Federal Open Market Committee (FOMC) in mid-December, the Federal Reserve reiterated its commitment to rate increases and to steady decreases in its holdings of bonds during 2019.

Both of these measures make loans more expensive, cooling off the economy to prevent increased inflation.

{mosads}At the press conference after this week’s meeting, Fed Chairman Jerome Powell vowed to be patient. We will “wait and see” what incoming data tells us, he said. When asked directly what had changed the Fed’s plans, Powell pointed to slowing global economic growth and to the effects of the recent (and perhaps upcoming) shutdown of the federal government.

Powell also noticed that financial conditions have tightened, meaning that loans and other costs and terms of getting financing for companies and households have become noticeably less favorable toward the end of 2018 and continuing into the new year.

According to Powell and his colleagues, the U.S. economy is still moving along nicely, with inflation pretty much where the Fed wants it, unemployment low and GDP growing. Powell spoke of slower U.S. growth this year, but he did so without anxiety.

When asked what might lead the Fed to raise interest rates, he commented that there would have to be strong signs of increased inflation.

The decision not to raise rates is a bit of an anticlimax at this point. Powell first proclaimed his willingness to be patient shortly after the last FOMC meeting in the face of rising discontent within the financial markets and the media.

Former Fed Chairwoman Janet Yellen chimed in with a comment that we have reached the peak of the tightening cycle, making explicit what Powell probably was thinking.

Powell, however, was left in a little bit of an unclear position. A reporter noted that Powell had previously stated that the current 2.25-2.5-percent target for the federal funds rate is still accommodative, stimulating the economy.

How could this be squared with his unwillingness to commit to interest rate changes either way? Powell argued that the current rate is appropriate, but did not comment on whether it is accommodative.

He simply stated that the current rate is at the lower end of the range of neutral rates expressed by FOMC members, without taking a personal stand on the question. So is the Fed accommodating or standing still or what?

Somewhat surprisingly, Powell did not seek to resolve this tension by citing the unusual level of uncertainty created by the shutdown, which prevented the release of important data that the Fed relies on.

Nor did he do more than briefly mention that key government policies, above all the trade dispute with China and the lack of clarity on the federal budget, make it especially difficult for the Fed to assess future developments.

Listening to Powell’s measured and careful answers, it becomes clear that the Fed is in the midst of a significant rethink but does not see a need to rush. Perhaps the most striking aspect of this rethink is Powell’s clear statement that the Fed is likely to stop shrinking its bond portfolio sooner than previously announced.

Powell had suggested that the shrinkage — known colloquially as quantitative tightening —  would be on autopilot, predictable but ongoing. While no new plan is ready, his answers and the Fed’s press releases clearly indicate a notable shift.

The portfolio shrinkage mainly impacts longer-term interest rates. These are the rates applying to corporate investment loans and home mortgages, critical areas of the economy.

Powell fended off two lines of questioning that challenge the Fed’s credibility. One is that the Fed caved to political pressure in calling off interest rate hikes. He stressed the changes in economic conditions that justified the change in interest rate policies, insisting that the Fed puts the health of the economy, not any political pressures, at the center of its deliberations.

While the answer is a good one, there is no getting around the fact that the Fed chair is in a very uncomfortable position.

The second line of questioning regards something called the “Powell Put.” The phrase first surfaced as a “Greenspan Put” back in the day. It refers to the perception that the Fed reacts to major decreases in share prices by lowering interest rates, putting a floor on the stock market.

To my mind, this whole idea is embedded in magical thinking. The Fed’s ability to actually affect share prices in a reliable manner is minimal. Even when the Greenspan Fed famously came to the rescue during the stock market crash of 1987, all it could do was provide lots of loans and a calming presence.

{mossecondads}If the Fed could raise share prices, lots of people would be much richer than they are. Macroeconomists like me would probably be very, very wealthy!

Furthermore, the Fed really only looks at share prices as one fairly small piece in the enormous mosaic of factors that affect the whole economy and, above all, inflation.

This FOMC meeting has confirmed that we are in a new phase. Most likely, rates will not go higher, but we will also not see a recession in our immediate future. “Wait and see” may turn into, “Wait for the recession to come.” But in this turbulent political world, it is probably wise not to predict too much, except more turbulence.

Evan Kraft specializes in the economics of transition, monetary policy and banking issues as a professor at American University. He served as director of the research department and adviser to the governor of the Croatian National Bank.