Earlier this week, Federal Reserve Chairman Jerome Powell testified before the Senate Banking Committee and the House Financial Services Committee.
Over the course of two days, Powell reiterated a more patient stance for monetary policy amid a seemingly optimistic view of the domestic economy marred, however, somewhat by “international crosscurrents.”
Aside from the future pathway for policy, Chairman Powell was also asked about a number of topics ranging from the U.S. labor market and the debt ceiling to international trade relations, as well as the administration’s economic policies.
The chairman was noticeably upbeat regarding the current state of the U.S. economy, reiterating positive sentiment conveyed in the January policy statement.
Powell expects the U.S. economy to continue to grow at a “solid” pace this year, although expanding at a somewhat slower rate relative to 2018.
Federal Open Market Committee (FOMC) members anticipated a 2.3-percent pace of activity in 2019 and 2.0 percent in 2020, although such forecasts are likely to be revised down somewhat come March in accordance with the chairman’s still positive, albeit reduced, outlook for domestic activity.
In its January statement, the Fed noted “international crosscurrents” and slower growth across a number of major economies as variables warranting a more sidelined approach to policy, at least for the time being.
In testimony this week, the chairman again issued a warning of mounting risks to the domestic economy stemming from a global slowdown, financial market volatility and uncertainty surrounding U.S. trade policy.
As a result, Powell said the Fed will be “patient” in any further policy adjustments with a renewed heightened focus on the evolution of the data.
When asked to quantify “patient,” Powell replied with neither a firm quantification nor a calendar-specific answer: “When I say we’re going to be patient, what that really means is we’re in no rush to make a judgment about changes in policy. We’re going to allow … the data to come in. I think we’re in a very good place to do that.”
Regardless of what specifically “patient” translates into, it is a distinctive shift from the Fed’s firm policy position just weeks prior. At the end of last year, the Fed indicated an intention to raise rates two additional times in 2019 following four interest rate hikes in 2018.
Forty-two days later, the FOMC did an about-face in terms of policy directives, shifting from a more aggressive tone to a more patient position.
Without an updated Summary of Economic Projections, many market participants have taken the adjustment in sentiment to mean the Fed has thrown in the towel on any future policy adjustments.
As of Dec. 20, the probability of one rate hike by the end of the year was near 40 percent. At this point, according to Bloomberg, the probability of no rate increases between now and the end of 2019 is near 90 percent.
Forecasters forecasting the Fed
Of course, not everyone is buying the committee’s change of heart on rates or its rose-colored assessment of conditions on the home front. According to the National Association of Business Economics (NABE) poll of professional forecasters, of which I am a contributor, the majority of respondents still anticipate at least some additional Fed action in the remaining 10 months of the year.
Predictions range from one to two rate hikes, potentially taking the upper bound of the federal funds target range to 2.75 percent or 3.0 percent. After all, with recession lurking around the corner, the committee may need at least some further tools in the proverbial monetary policy toolkit to combat eventual weakness.
Furthermore, the U.S. economy, in the chairman’s own words, “is in a good place,” with growth near 3 percent and inflation near 2 percent, the very conditions that warranted relatively aggressive policy action over the past few years.
So while the Fed may be pausing to smell the roses, or at least better assess geopolitical risks ranging from Brexit to trade policy, according to some NABE respondents, the committee’s still-optimistic assessment of domestic conditions as they relate to the Fed’s dual mandates of stable prices and full employment potentially warrants a continued backup in rates.
At this point, international contagion via reduced global growth and disinflationary or outright deflationary conditions may be the primary cause for policy patience, but the window of opportunity for any further Fed action is rapidly dwindling as the focus is bound to shift to the home front in the coming months.
Compounding domestic weakness will expectedly become more evident beginning in the second quarter, which could serve to block any further policy action and permanently sideline the Fed going forward.
In other words, if the more hawkish members of the Fed wished to make a case for at least one additional hike, the prime opportunity is just 19 days from now before a domestic slowdown replaces global weakness as the primary catalyst for patient policy.
Of course, with an expected slowdown and rising risk of recession here at home, why hike even anther 25 basis points (bps) and risk front-loading economic contraction sooner than later?
Coupled with a divergence in opinions regarding the pathway for rates over the next 12-24 months, professional forecasters also question the committee’s “solid” assessment of the domestic economy.
At the same time, the majority of forecasters reportedly expect another 25-50 bps in hikes in 2019, the same predictors also anticipate recession in the near term, perhaps reflecting the differential between what the Fed will likely do and what the Fed should do.
Seventy-five percent of survey panelists, myself included, anticipate an economic recession by 2021. While only 10 percent expect a recession in 2019, 42 percent say a recession will likely happen in 2020 and 25 percent expect one by 2021.
Thus, while the committee may feel confident in the state of the economy, most independent economists question the sustainability of the expansion for even another 10 months.
A majority of respondents expect the economy to continue to benefit from the Trump administration’s deregulatory agenda.
Although, nearly 50 percent believe the positive effects will be substantially muted relative to the first few years of the administration’s tenure, particularly as newly-appointed officials — as well as some presidential hopefuls — have indicated a desire for increased regulation on the country’s major banks and financial institutions.
Furthermore, with most assigning a very small probability of a divided Congress passing an infrastructure bill, many lament the notion of a potentially sizable net stimulus for the economy failing to come to fruition.
More broadly, with waning momentum on the part of the consumer facing lackluster wage growth over much of the past decade, moderating business investment, early signs of weakness in the housing market and a rising threat of disinflation imported from deteriorating global market conditions, the prospect from slower domestic growth appears to be mounting with the risk of recession rapidly rising over the coming 12-18 months.
If the Fed doesn’t take further action while there is arguably still a chance, the next move will likely be a rate cut to help combat an economic contraction.
Lindsey Piegza is the chief economist for Stifel Fixed Income. Her research has been published in the Harvard Business Review and in textbooks for Northwestern University's Kellogg School of Management. She's a regular guest on CNBC, Bloomberg, Fox News and CNN.