The FOMC has begun 2019 on a much more cautious footing, with global risks front of mind. Further out, rate hikes are still expected.
The FOMC’s January post-meeting communications carried a much more cautious assessment of the outlook. This was not because their core view of the US’ real economy has changed materially, but rather owing to greater concern over global “cross-currents” – how Chair Powell and the Committee refer to risks.
In January, their characterisation of the US’ real economy remained robust. On the back of “strong” job gains and a “low” unemployment rate, household incomes continue to strengthen, supporting “strongly” growing household spending. Though “business fixed investment has moderated”, this is from the “rapid pace” of early 2018 – hence current momentum is still best regarded as robust.
Looking ahead, the “Committee continues to view sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective as the most likely outcomes”. With slack in the labour market very low and the federal funds rate range mid-point just below the Committee’s estimated neutral range of 2.5%–3.5%, an expectation of continued above-trend growth arguably justifies a further tightening of policy.
At present however, for the FOMC, so-called “cross-currents” (risks) are a barrier to doing so.
These risks to the central view are many and varied, and their potential combined effect on the US economy is highly uncertain. By and large, for the FOMC, these risks remain global in nature.
First port of call for Chair Powell in the press conference was the deceleration in growth seen in China and other emerging markets. Lingering trade tensions between the US and China are a factor here, one that could spark a further deterioration in conditions if ongoing negotiations fail to find a lasting solution.
The other key global risk currently in focus for the Committee is the uncertainty surrounding the UK and Europe owing to Brexit. The Committee is aware that a hard Brexit would have direct economic and financial impacts on the US, and indirect secondary consequences via confidence in the global economy. A ‘soft’ Brexit could also be negative for the US, depending on its terms.
On domestic risks, while the government shutdown of December and January has ended, the terms and timing of a lasting solution to this issue are a long way from being agreed. The re-emergence of the debt ceiling in mid-2019 and the need to decide on a new level for government spending from 1 October 2019 (after 2018/19’s extraordinary fiscal stimulus ends) means that ‘US fiscal risk’ could remain abnormally elevated through 2019.
It is therefore unsurprising that the FOMC is taking a “patient”, wait-and-see approach with policy. Rate hikes are not off the agenda for 2019, but they will have to be justified by the data flow. In the press conference, Chair Powell made clear that inflation (actual and expected) will be pivotal in any decision to hike, given above-trend growth and a tight labour market is already built into their base expectation.
Like the FOMC, we see both global and US-specific risks as likely to recede through the first half of 2019 while US growth holds above trend. Combined with an expectation that the latter will persist in 2020, this should justify a shift in the stance of policy to within the FOMC’s neutral range. 25bp hikes in June and September 2019 would take the federal funds rate to the middle of that neutral range. This stance shouldn’t impede materially on GDP growth, but would provide the Committee capacity to react to any and all eventualities. We must stress again though that this policy view is dependent on current risks dissipating and no new shocks emerging. The data and political flow will prove critical for the timing and direction of US monetary policy in 2019.
