Wednesday, February 5, 2020

Fed on Hold as Inflation Remains Stubbornly Below Fed’s 2.0% Target

I believe that the 1/29 Federal Open Market Committee (FOMC) statement and Federal Reserve Chair Jerome Powell’s same-day press conference suggest that the Fed is likely to stay on hold through the end of this year. Furthermore, the Fed’s next move, whenever that comes, is likelier to be a rate cut than the start of more hikes. That’s because Fed officials remain concerned that inflation has stayed stubbornly below their 2.0% target.

Last year, the FOMC cut interest rates three times—on 7/31, 9/18, and 10/30—by a total of 75 basis points, from the 2.25%–2.50% range to 1.50%–1.75%. The committee voted to keep the range unchanged at both its 12/11/19 and 1/29 meetings. So far this year, comments from voting Fed officials indicate that the FOMC is likely to hold rates where they are for now.

During his 1/29 presser, Powell stressed that he is concerned that persistently low inflation might continue to weigh on interest rates. In that case, the Fed would have less room to reduce the policy rate “to support the economy in a future downturn, to the detriment of American families and businesses.” He added: “We have seen this dynamic play out in other economies around the world, and we are determined to avoid it here in the United States.” It’s not clear how he intends to do so.

Here are more takeaways from Powell’s 1/29 presser:

(1) Word game. Only two words were meaningfully changed in the FOMC statement released on 1/29 from the one on 12/11, according to the WSJ’s Fed Statement Tracker. It noted that “household spending has been rising at a moderate pace” rather than a “strong” pace and that inflation is “returning to the Committee’s symmetric 2 percent objective” rather than “near” the objective. So both the pace of household spending and the outlook for inflation were downgraded.

(2) Still pushing for more inflation. During the Q&A, Powell explained that the change in inflation language was to prevent any misinterpretation, specifically the impression that “near” the Fed’s goal might suggest that officials are comfortable with the inflation rate as it is running now. Au contraire, officials wanted to “underscore” their “commitment” to 2.0% inflation as a target to be achieved “symmetrically,” not as a “ceiling” to an acceptable range. That’s especially so now, when we are well along into an economic expansion with very low unemployment, a time “when in theory, inflation should be moving up.”

Powell cited November inflation figures as measured by the headline and core PCED (i.e., the personal consumption expenditures deflator) at 1.5% and 1.6%, respectively. December’s readings, released on 1/31 (two days after the presser), were similar at 1.6% for both measures.

In his opening remarks, Powell said the Fed expects inflation to move closer to 2.0% “over the next few months as unusually low readings from early 2019 drop out of the calculation.” But he suggested that moving closer to 2.0% may not be enough to cause the Fed to hike rates; he’d prefer to see inflation overshoot the Fed’s 2.0% “symmetric” target to boost confidence that inflation can be sustained at that rate. Powell had made the same point last year at his 10/30 press conference: “[W]e would need to see a really significant move up in inflation that’s persistent before we would consider raising rates to address inflation concerns.”

(3) Six major uncertainties. Powell said the Fed expects “moderate economic growth to continue” with supportive monetary and financial conditions, but “uncertainties about the outlook remain.” He listed six areas of concern: weakness in business investment and exports, declines in manufacturing output, sluggish growth abroad, trade developments, and the new outbreak of the coronavirus. “We are not at all assured of a global rebound,” he cautioned, “but there are signs and reasons to expect it. And then comes the coronavirus which, again, it’s too early to say what the effects will be.”

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