As expected, the Federal Reserve opted to hold rates steady in its March policy announcement. But while Wednesday’s decision was as expected, there was a larger question mark surrounding the longer-run pathway for rates.
In December, the dot plot — the visual representation of Fed policymakers’ expectations for the fed funds rate — showed the Fed hiking rates potentially twice more in 2019. The latest version showed no further Fed action in the remaining nine months of the year, just one hike in 2020 and again none in 2021, in line with market expectations.
{mosads}According to Bloomberg, the market has assigned a 73-percent probability of no further Fed action in 2019. Of course, the dot plot, as Chairman Jerome Powell has emphasized time and time again, is just a forecast, not a commitment.
Still, the reduction in proposed action suggests the vast majority of officials believe the current level of policy is at, or at least near, neutral as opposed to being accommodative.
Furthermore, it seems unlikely that after a prolonged period of pause, the Federal Open Market Committee (FOMC) — the Fed body that sets the fed funds rate — would go back to hiking 12 months later. Historically, after the Fed takes to the sidelines, the next course of action is a reduction in rates.
Still relatively optimistic regarding the current state of the economy, the March statement and Summary of Economic Projections (SEP) reflected a noticeable reduction in the expected level of output over the next 12-18 months.
According to the statement, growth remains “strong” but has slowed from a more solid rate last year amid slower consumer spending and business investment as well as waning price pressures, sentiment aligned with the chairman’s recent interview on 60 Minutes.
Additionally, the FOMC reduced its forecast for growth from 2.3 percent to 2.1 percent in 2019 and from 2.0 percent to 1.9 percent in 2020. The FOMC’s inflation forecast was lowered from 1.9 percent to 1.8 percent in 2019 and from 2.1 percent to 2.0 percent in 2020.
While still a modest expectation for growth and inflation at near 2 percent each, policy officials clearly see a downward bias in the underlying economy.
For the market, the latest policy announcement seems to be the best of both worlds. After all, the Fed has indicated it will remain indefinitely on the sideline against the backdrop of a still-steady rate of expansion in the domestic economy.
Unlike past Feds, which continue to tighten until the data clearly weakens, the Powell-Fed appears willing to back off even as growth remains somewhat steady. As a result, equities rose following the Fed’s rate announcement.
Of course, reading between the lines, it is clear the Fed sees mounting downside risks to the economy — both global and domestic — which means the conversation among committee members is likely to shift from achieving neutral policy to implementing a defensive strategy in the coming quarters.
In other words, it’s no longer about whether the Fed can slide in one additional rate hike at some point in the future, but when will the first rate cut come into play?
As the weakness becomes more prevalent, the Fed will be forced to take action sooner than later, potentially by early next year or even later this year if the economy deteriorates at a faster than expected pace.
Aside from rates policy, the Fed has also indicated right-sizing the balance sheet by September, provided the “economy and money market conditions evolved as expected.” Beginning to taper the taper in May, the Fed will slow the monthly reduction of its Treasury holdings from up to $30 billion to up to $15 billion.
On the mortgage-backed securities (MBS) side, the current $20 billion cap will remain in place for the time being. In October, however, proceeds up to as much as $20 billion per month would at that point be reinvested in Treasuries while runoffs in excess of $20 billion will be reinvested in agency-backed MBS.
The market is reading the Fed’s new balance sheet management program as Treasury-friendly, although there still remain a number of questions in terms of purchases and duration once quantitative tightening ends.
Lindsey Piegza is the chief economist for Stifel Fixed Income. Her research has been published in the Harvard Business Review and in textbooks for Northwestern University’s Kellogg School of Management. She’s a regular guest on CNBC, Bloomberg, Fox News and CNN. Follow her on Twitter: @LindseyPiegza.