The Fed wants to be boring, but Trump, markets won't let it

The Fed wants to be boring, but Trump, markets won't let it
© Getty Images

Wednesday, the Fed released the minutes from the Federal Open Market Committee (the committee that sets the Fed’s interest rate policy) from Dec. 18-19.

The minutes give a detailed look at the Fed’s thinking on the state of the economy. Although quite dry and technical, they can provide a good deal of insight into the Fed’s concerns.

ADVERTISEMENT

This time, there was little dramatic to report. There has been a dichotomy between strong and stable economic activity and turbulence in financial markets, but so far the sound and fury has not added up to very much.

When I say strong and stable economic activity, I mean that the output of the economy (real GDP) has been growing at a fairly steady and rapid pace for a while now.

Unemployment is low, at least measured in the conventional ways, and inflation is right where the Fed would like it to be. To use a 1990s phrase, it looks like a Goldilocks economy in many ways.

The dichotomy is that share prices have fallen sharply, share price volatility is up quite a bit, and interest rates charged to riskier companies are rising. The yield curve, which shows how interest rates vary according to the length of time the money is lent out, has gone almost flat.

These financial factors suggest something less than a strong and stable economy. The Fed staff suggests that increased trade tensions with China, concerns over global growth prospects and questions about the sustainability of corporate earnings could be behind these financial trends.

However, even though we do not need to be reminded about how important the financial sector is since the 2008 meltdown, considerable financial market jitters do not necessarily translate into immediate, big consequences for the economy.

At this point, the biggest area of weakness in the U.S. economy is seen in the housing market, where sales of new homes in particular have been fading for a while.

This might be the result of the Fed’s interest rate hikes: Most home buyers need loans, and these loans often loom large in households’ budgets. Increasing interest rates can put home buying out of reach for some.

The decline in home buying is pretty typical of the late phase of an economic expansion; so are falling share prices. Historically, these two alarm bells have sounded well before a recession starts. Neither would really constitute a sign of imminent recession. In fact, the Fed continues to predict strong growth in 2019.

The prediction of growth faster than the growth of the economy’s potential can be read as clear message that more interest rate increases are on the way.

Still, the minutes do show some rethinking by FOMC members. Several members slightly lowered their expectations for growth in 2019. As a result, members’ predictions of the federal funds rate in 2019 eased a little too, with two members actually predicting no increases at all during the year.

This can be seen from the “dot-plot” that shows FOMC members' predictions about the federal funds rate. This and another graph showing the range of committee members’ predictions for GDP growth, inflation and unemployment give the public quite a detailed view of the FMOC’s thinking.

Amusingly, the minutes note that the public’s perception of the Fed’s thinking has changed. Various methods suggest that the public expects the Fed not to raise rates in 2019 as much as it had initially suggested. This is useful information for the Fed, but it certainly does not tie their hands or determine their decisions.

Overall, the minutes suggest that the Fed is growing a little less determined to keep raising interest rates. The economy still seems strong to them, but they are less sure about what will happen and more focused on incoming data than they have been recently.

The signs of incipient recession might be starting to develop, but chances of an uptick are also significant. Things could easily get more exciting.

Former Bank of England Governor Mervyn King likes to say that the job of central bankers is to be boring. That is great when you can do it. The Fed is trying to be boring, but neither the president nor the economy will let them be. Look out for more interesting times ahead.

Evan Kraft specializes in the economics of transition, monetary policy and banking issues as a professor at American University. He served as director of the research department and adviser to the governor of the Croatian National Bank.