The Fed’s policy statement, the revised dot plot, and Chair Powell’s press conference reaffirmed expectations that monetary policy will remain on hold for the foreseeable future. That doesn’t mean that rates won’t be changed. The Fed stands ready to provide further accommodation if conditions warrant. However, the hurdle for a rate increase appears to be relatively high.
At every other Fed policy meeting (four times per year), senior Fed officials (the governors and 12 district bank presidents) submit projections of growth, unemployment, and inflation. Officials generally expect GDP growth to be in the 2.0-2.2% range for 2020 (4Q/4Q), with a median forecast of 2%. That seems a little optimistic, but is not out of the question. Labor market constraints are likely to become more binding and labor force growth should be slow (to about 0.5% per year given the demographics and limitations on legal immigration). Of course, the central bank would be the first to admit that there could be a lot more slack in the labor market. Fed officials misjudged the tightness in labor market conditions as they raised rates in 2018 (although by most accounts, monetary policy remained accommodative even after the December 2018 hike). In normal circumstances, the unemployment rate understates the strength of the labor market when conditions are strong (as those on the sidelines, not officially counted as “unemployed,” are drawn back into the labor force) and understates the weakness when conditions are weak (as individuals drop out of the workforce and are no longer considered “unemployed”). The unemployment rate has come to be viewed as a less reliable measure of labor market slack. One can get around the participation issue by looking at the employment/population ratio, which for the 25-54 year cohort is currently back to where it was before the recession.
While wage pressures have picked up, they remain generally moderate. That could change, but until it does, there is likely to be limited upward pressure on inflation. While Chair Powell spoke against the Fed adopting a make-up policy for inflation, he appeared reluctant to raise short-term rates until the Fed reaches its 2% goal. This is a change, as the Fed has long believed that if the Fed waited for higher inflation to show up, it would be too late to prevent it from rising further. In other words, the policy of preemptive tightening ahead of inflation appears to be out the window.
While the Fed appears to be somewhat optimistic about the prospects for growth in 2020, the central bank still sees downside risks. Slower global growth and trade policy uncertainty dampened growth in 2019 and inflation pressures were unexpectedly muted. The truce in trade tensions is welcome, helping to reduce the downside risks to growth in 2020, but a lot of damage may have already been done. Import and export decisions do not turn on a dime, and more work needs to be done. Trade policy has generally been “one step forward, two steps back,” but the focus should be on reducing impediments to growth in an election year.
We ought to see the global economy pick up in 2020. Brexit may generate some turmoil, but simply removing the uncertainty would be a plus. Emerging economies should be helped by the Fed’s three rate cuts.
The Fed can be patient in deciding its next move, but we’re unlikely to see any changes through the first half of 2020.