Federal Reserve – A changing of the Guard
The January Federal Reserve Open Market (FOMC) meeting will likely be remembered for being Janet Yellen’s last meeting as Chair of the Board of Governors of the Federal Reserve System. President Donald Trump decided not to nominate her for another four-year term, choosing instead to replace her with Jerome (Jay) Powell, who was already a serving member on the Board of Governors. His elevation to lead the Fed places the U.S. central bank in the hands of a non-economist for the first time since G. William Miller in 1978-1979, a period associated with high inflation and high unemployment. Even though Powell is somewhat of a ‘known quantity’ who voted with Yellen through her term, the number of other open positions yet to be filled at the Fed sets the FOMC to be a little ‘green’ in terms of economic and/or central bank experience when compared to recent years.
Teeing up a March hike
The Fed’s most recent rate forecasts (the ‘dots’) released in December projected three 0.25 percent hikes in 2018 and following the January FOMC meeting, rate hike probabilities for the March meeting sit at 99 percent; leaving little doubt. The forecasts show little movement from the Fed’s gradual, deliberate path to higher rates they began in December 2015, which has produced five 0.25 percent rate hikes since then.
For some time now, the Fed has maintained a data-dependent approach in determining how fast/slow to raise rates, focusing primarily on employment, economic growth and inflation. Of those three data points only inflation has proved disappointing to policy-makers as it has remained stubbornly below their two-percent target; core Personal Consumption Expenditures (PCE) the Fed’s favored inflation barometer, currently at 1.5 percent has been below the 2 percent target for six years. Despite this disparity, the statement from the January meeting indicates the Fed remains steadfast in their belief inflation will progress toward 2 percent, which will likely keep a steady stream of rate hikes on the table.
Even so, recent Fed statements indicate there are questions as to the effectiveness of the current target and there is a concern that as open Fed positions are filled, policymakers could consider adjustments to the inflation target which might translate into a more aggressive monetary policy stance. For now, however; it appears any changes to the inflation target and/or calculations will be long-term events, not something that happens in 2018.
Timing for the next two hikes?
Since launching this new rate hike cycle in December 2015, the Fed has preferred to use the quarterly FOMC meetings (March, June, September and December) to adjust policy. So assuming March is a go for a rate hike, when might the next occur? From recent Fed statements we know there are a number of variables important to future policy decisions that may take some time to fully develop – the impact of tax reform on growth, low inflation, easy financial conditions and flat yield curves.
As a result, the Fed could follow a path similar to 1990 when they paused after a rate hike to assess its impact as well as developments in these variables. This could mean the pause comes at the June meeting and the last two hikes for 2018 come in September and December.
Changes to this outlook?
The Fed is always careful to note forecasts are just that and nothing is set in stone. In fact, since the first rate increase in 2015, last year was the first where they achieved their early-year rate hike forecasts. Even for 2018, investors should note there are street forecasts for more – four - and fewer – two - rate hikes this year. Whichever path the Fed ultimately takes will depend upon changes to the aforementioned variables; for now we are comfortable with the current three rate hike forecast.