Tighter financial conditions and slower global growth have weakened arguments that U.S. monetary policy will be restrictive in the coming years to alleviate the risk of economic overheating or growing financial imbalances. However, in line with our expectations, recent market volatility was not enough to change FOMC (Federal Open Market Committee) participants’ views that the outlook for above-trend U.S. growth in 2019 necessitates neutralmonetary policy. In the end, Wednesday’s FOMC statement, updated economic projections and Chairman Powell’s press conference brought the committee more in line with our outlook for one to two interest rate hikes in 2019.
Subtle but important shifts in Fed communication
As expected, the Fed on Wednesday raised its policy rate by 25 basis points (bps), bringing the effective fed funds rate just below the Fed’s 2.5% to 3.5% range of estimates for neutral monetary policy. The Fed also modified its previous statement language, now noting that only “some” further gradual increases are necessary, to allow for greater uncertainty and more flexibility about the future direction of interest rates as the Fed enters the range of estimates for neutral policy.
Perhaps more interestingly, in the Summary of Economic Projections (SEP), FOMC participants downgraded their expectations for the appropriate path of monetary policy, resulting in a 25 bp decline in the level of the median path in 2019, 2020 and 2021. The median participant also downwardly revised their 2019 growth and inflation expectations, and, notably, the median core PCE inflation forecast is no longer above the committee’s longer-run 2% inflation target (PCE, or personal consumption expenditures, is the Fed’s preferred inflation measure).
Overall, we view these revisions as largely consistent with our estimates of the economic implications of the recent tightening in financial conditions. Indeed, we estimate that tighter financial conditions since the September SEP could reduce 2019 real GDP growth by 0.3 to 0.4 percentage points – a little more than the FOMC’s median forecast revision, which brought down their 2019 real GDP forecast to 2.3% annualized (from 2.5% previously). However, it’s important to keep in mind that despite the revision, PIMCO and most FOMC participants continue to expect that above-trend real GDP growth will push the unemployment rate lower, necessitating a neutral stance for monetary policy.