Chairman Jerome Powell signaled the Federal Reserve won’t raise interest rates again until inflation accelerates in a dovish pivot that left many investors betting against any further hikes in this economic expansion.
Not only did central bankers drop a reference to “further gradual increases” in their statement on Wednesday, they implied the next move could just as likely be down as up. They also announced a more flexible approach to shrinking their bond portfolio, another acknowledgment of the recent financial market angst over tighter monetary policy.
“Short of announcing that a rate cut is in the cards, this is about as dovish a statement as possible,” said Ian Shepherdson, chief economist at Pantheon Macroeconomics Ltd. “Policy makers appear to be going all-in on the slowdown story.”
After nine increases since 2015, Goldman Sachs Group Inc. economists said they now see just a 25 percent probability of the federal funds rate being lifted in the second quarter from the current 2.25 percent to 2.5 percent, down from 55 percent previously.
Many described the Fed’s actions as a capitulation to worried financial markets, or, as Societe Generale SA’s Omair Sharif put it, “a letter of apology.” The Fed may also face the charge it bowed to complaints from President Donald Trump, who took to Twitter on Wednesday to cheer the surge in stocks that followed the new tone.
It was a sharp contrast with a much more hawkish Fed in December. With markets already in turmoil, Powell came across in his press conference then as somewhat dismissive of investor concerns that officials were intent on hiking too much this year. At the same meeting, Fed officials submitted forecasts that included a median expectation for two rate increases in 2019.
Asked Wednesday in his latest press conference if the Fed still saw its next rate move as more likely to be up than down, Powell made it clear that was not his expectation.
“It’s going to depend entirely on the data,” he said. “I would want to see a need for further rate increases, and for me, a big part of that would be inflation. It wouldn’t be the only thing, but it would certainly be important.”
Equity markets reacted warmly with stocks advancing on Thursday around the world as investors sought out risk. The dollar and Treasury yields extended declines.
What Bloomberg Economics Says “The guidance strongly implies that Fed officials are contemplating the end of the tightening cycle. We remain of the view that the terminal fed funds rate of the current cycle has not yet been reached and policy makers will need to resume moderate additional rate hikes following a multi-quarter pause.”–Carl Ricadonna, Yelena Shulyatyeva and Tim Mahedy, Bloomberg Economics Click here for the research
The Fed’s dovish switch came across as particularly surprising as officials continued to characterize the U.S. economy as “solid” in their policy statement.
“This change was not driven by a major shift in the baseline outlook for the economy,” Powell said. “We view the baseline as still solid.”
The Fed could still have made life difficult for itself later this year if its own baseline forecast proves correct and additional rate increases prove warranted.
Michael Feroli, chief U.S. economist at JPMorgan Chase & Co., who still predicts two rate hikes this year, said the overall dovish message “is almost encouraging the market to keep a rate cut priced in. It’s going to be tricky messaging,” he added, if the committee determines hikes are needed later in 2019.
Read More This Is What It Sounds Like When Fed Doves Cry: John Authers Fed Gives the Markets What They Want: Mohamed A. El-Erian Fed’s Pause Allows Emerging-Market Central Banks to Exhale Bulls Cheer as Fed’s Capitulation to Markets Reaches Climax
Confusion could come soon, according to Wrightson ICAP LLC chief economist Lou Crandall, if Fed officials project any further rate increases when they next submit economic forecasts. “The markets will feel misled if the March dot plot is still upwardly sloping,” he said.
To be fair, Powell tried to justify the shift by sketching out risks to the U.S. economy in starker terms than he had previously, highlighting the faltering international environment.
“The narrative of slowing global growth continues,” Powell said. “We’ve seen that both in China and in western Europe.”
Powell also drew fresh attention to concerns over “muted inflation pressures.” Inflation struggled for many years to creep back up to the Fed’s 2 percent target, reaching it briefly in mid-2018. But officials sound less confident now that it won’t slip meaningfully below their target again.
Still, Wednesday’s performance will likely raise more questions about Powell’s penchant for delivering a message well outside investor expectations. The chairman, who took over from Janet Yellen in February, has repeatedly whipsawed markets.
He first roiled markets in October with a comment on the so-called neutral rate that was construed as hawkish, then walked it back in a subsequent speech. He and other Fed officials again were forced to pull back on the message that emerged from the December meeting, ramping up their references to being “patient.”
With markets mostly calm, few expected Powell to outdo that message with Wednesday’s retreat.
“I worry about a loss of credibility given the rapidity and magnitude with which the statement has changed in recent months, against an backdrop that doesn’t appear to have changed all that much,” said Michael Gapen, chief U.S. economist at Barclays Plc.
— Christopher Condon (Bloomberg)