The January minutes of the Federal Open Market Committee clearly indicated increasing concern about turmoil in financial markets and global trade tensions between the United States and its trading partners. The Fed hinted at a slower pace of growth due to asset volatility and the international economy. Trade tensions and financial volatility spilled over into the real economy in December 2018, and were followed by soft economic data. The uncertainty tax placed on U.S. businesses, primarily due to trade and rate policy, has resulted in a policy shift at the Fed, which is reacting prudently in light of rising risks. As such, the Fed based on its minutes on setting up to end its balance sheet reduction later this year and will likely announce that at its March meeting. Moreover, it is clear that the core of the committee is unsure of the direction of rate policy, and thus expect to observe a general downward revision of growth forecasts across the board; this implies possible rate cuts in 2020, should the economy not rebound from what is now a sub-2-percent GDP growth trend.
While the minutes provided insight into the reversal of policy by the Fed at its January meeting, investors will not get the action they seek until the March FOMC meeting. What investors want is a clear sense of the timing and magnitude of the draw down of the Fed’s balance sheet and the inevitable downgrade of its summary of economic projections on growth and interest rates. Therefore, we expect the next month or so of Fed rhetoric to begin shaping expectations around this and further explanation of the direction of rate policy.
We have thought for some time that the Fed is preparing to modify its policy and communications regime. The minutes strongly hinted at the probability that the “dot plot” may have a short life span ahead. Most importantly, in the unenumerated penumbras of the statement, one gets the sense the Fed is going to retreat to a more Bernanke-like policy stance with respect to the inflation target. In other words, when it comes to the inflation target, 2 percent does not always mean 2 percent. We would not be surprised at all if the FOMC moves toward what one might refer to as an inter-temporal target. Thus, as long as the target averages 2 percent over a specific time frame, then the risk around dislodging inflation expectations is low and provides much-needed policy space for central bankers to be patient.
