The Federal Reserve now expects that 2019 will pass without a single interest rate hike as it anticipates that economic growth will weaken, but this dovish stance has prompted some criticism.
At this week’s meeting of the Federal Open Market Committee (FOMC), the central bank held interest rates in their current range of 2.25 to 2.50 per cent and lowered its US growth outlook to 2.1 per cent, down from the 2.3 per cent it forecast in December.
Federal Reserve chairman Jerome Powell said: “We foresee some weakening but we don't see a recession.”
While adding that the US economy “is in a good place”, Powell also noted that average monthly job growth “appears to have stepped down from last year’s strong pace” (while remaining generally strong) and that weakness in areas such as consumer spending and business investment “suggest that growth is slowing somewhat more than expected”.
The Fed’s ‘dot plot’ – March 2019
Source: Federal Reserve
Crucially, the Fed’s officials now believe that no more interest rate increases will be needed in 2019, as revealed in the bank’s closely watched ‘dot plot’ – which is shown above.
Furthermore, most officials see a single rate increase in 2020 and none in 2021. When the forecasts were last released in December, Fed officials expected two rate increases this year and another in 2020.
Ian Shepherdson, chief economist at Pantheon Macroeconomics, said the outcome of the latest FOMC meeting can be summed up in one line: “An accident waiting to happen.”
“The disappearance of both dots is an unnecessarily bold move – markets were not screaming for it – and it runs the risk of the Fed having to reverse course in the summer, when the ‘cross currents’ likely will have faded and wage pressure will become the Fed’s biggest concern,” he explained.
“Markets already are pricing-in a much bigger chance of an easing this year than before the meeting, but that’s only going to happen if some of the external risks – a dramatic worsening of the trade war with China, a further deterioration in global growth or a crash-out Brexit – materialise.”
Shepherdson added that the Fed does not want to publicly predict the outcome of political decisions but the removal of both 2019 dots suggests it is much more worried about external risks than Pantheon Macroeconomics believe is justifiable as a base case.
The Fed’s US GDP projections – March 2019
Source: Federal Reserve
He suggested that the central bank’s policymakers could have retained their flexibility and not boxed themselves into a corner by saying that they would simply respond appropriately to any negative events and be patient in the meantime.
Instead, the strategy of dropping the 2019 hike forecast to zero in 2019 (when the Fed’s officials were expecting three as recently as September) has left the bank “very exposed” if wage gains continue to accelerate and inflation rises as a result, according to the economist.
“The Fed, in our view, has put itself into a position where one or more of the external headwinds have to crystallise if the expectation of zero hikes this year is to prove correct,” Shepherdson argued.
“We expect a China trade deal soon and a turning point in China’s cycle by mid-year. We do not expect a Brexit crash-out and we think Congress will avert the fiscal cliff implied by current spending plans by raising spending in the summer; 2020 is an election year, after all.
“Accordingly, we still expect the Fed to hike twice this year, in September and December. Ultimately, the Fed does what the data dictate; it’s all about wages.”
Anna Stupnytska, global economist at Fidelity International, is another who believes that the Fed’s move to ‘out-dove’ the market’s already very dovish expectations could cause problems further down the line.
She noted that in addition to the change in the ‘dot plot’, the central bank said its balance sheet run-off – or scaling back the huge portfolio of bonds it built up under quantitative easing – will end in September, earlier than overall market expectations.
Stupnytska warned that the very dovish positioning may have left the Fed with little room for manoeuvre should data surprise on the upside later this year: “The dovish pivot may soon come back to bite them.
“The combination of easier financial conditions, continued tightening in the labour markets and some improvement in growth and inflation later in the year might necessitate another policy pivot, putting the Fed back onto the policy normalisation trajectory,” the economist added.
“This remains our base case. Given the current expectations of no more rate hikes, markets would be vulnerable in that scenario.”
The Fed’s US inflation projections – March 2019
Source: Federal Reserve
However, Janus Henderson co-head of global bonds Nick Maroutsos believes that the Fed will stand by its plan to keep rates at current levels. Indeed, he thinks the central bank will cut rates next.
He pointed of that markets take comfort in stable and consistent messaging and central to the Fed’s messaging is a high level of transparency.
Unlike Pantheon Macroeconomics’ Shepherdson, the manager sees plenty of credible risks that necessitate a dovish stance from the world’s central banks and could force a further loosening of monetary policy.
“The global environment is fraught with heightened geopolitical risk and threats to economic growth, including – but not limited to – US-China trade tensions, European political challenges and Brexit negotiations,” Maroutsos concluded.
“Our core view is that the Federal Reserve will keep rates on hold for the balance of 2019. We believe that if the Fed is done hiking, other central banks will follow suit. Furthermore, it is our expectation that the next move by the Fed will be to cut interest rates.”