As predicted, yesterday’s FOMC meeting ended with no change in policy, with all members on board with keeping the fed funds rate within a range of 2.25-2.50%. The formal statement was very little changed, noting continued strength in the labor market and economic growth; however, household and business spending were noted as slowing in the first quarter.
Demonstrated by the drama of the V-shaped financial market reaction from Q4-2018 through Q1-2019, many strategists have been surprised by the speed and magnitude of the Fed’s change in tone from moderately hawkish to much more dovish. The accompanying deceleration in economic progress around year-end has caused fed funds futures probabilities to now price in about a 50% chance of a rate cut by September and 65% chance of one by December, which is a different story than the Fed’s own comments over the past several months of ‘patience,’ and that more rate hikes could come prior to cuts.
The dashboard of Fed mandate items looks similar to recent readings, and while the most recent data is mixed to lackluster, there appear to be hopes for stronger growth in some camps slated for later in 2019. On net, in looking at all measures, conditions continue to look relatively neutral.
Economic growth
The advance growth number for Q1 GDP came in at 3.2%, better than expectations, but this included some idiosyncratic elements such as inventories and the government shutdown. Full-year growth rate expectations, though, remain in the mid-2’s, while estimates for the next few years (absent a recession in the interim) decline to about 1.5-2.0%. Being neither ‘hot’ nor ‘cold,’ this appears to be a generally neutral influence on Fed policy, although continued growth could warrant slowly normalizing rates.
Inflation
Recent inflation numbers, measured by CPI and PCE especially, have come in several tenths lower than the 2.0% Fed target. Volatility in oil prices have played a role in the headline number’s rate of change over the past year, but core inflation has also bucked expectations for a pick-up. Continued low levels would act as a reason for the Fed to stay put, as one of the primary reasons for hiking rates is to keep a lid on inflation pressures. Currently, we have the opposite situation, where, due to a variety of reasons, inflation has fallen off in recent months in keeping with year-over-year changes in commodity prices but also decelerating home price increases and flatness in other sectors.
Employment
While the pace of improvement has flattened a bit, overall levels remain very strong, whether it be payrolls, unemployment rate, or jobless claims. The strength in this metric would be a reason to tap on the brakes by continuing a raising rates program.
Fears of recession have already been cropping up and dominating the conversation. Much of this has been due to a slowing in overall global growth, with China being the swing element in those assumptions, although Europe and Japan remain in deceleration. However, as growth there appears to have tempered, the slowdown fears have also pulled back a bit. There still appear to be a variety of cross-currents at play, and while market valuations have normalized, the future continues to look dependent on the direction of global growth prospects, as neither re-acceleration nor deceleration paths seem clear.
