The Fed: One hike and a flock of dovish signalsContributor Dr. David Kelly
The Federal Reserve raised its target for the federal funds rate to a range of 2.25%-2.50% . This was widely anticipated until recent market volatility and concerns over economic growth had markets uncertain about the Fed’s next move. Yet, the Federal Open Market Committee (FOMC) statement highlighted the strengthening labor market and economic activity, in particular job gains and household spending.
- The FOMC released its economic projections, lowering expectations for real GDP growth to 3.0% from 3.1% for 2018, and to 2.3% from 2.5% for 2019. However, its long-run projection inched up to 1.9%. This reflects a likely moderation in near-term economic growth after an acceleration in Q2 and Q3 of this year. The unemployment rate is expected to be slightly higher in 2020 and 2021 than previously projected, although slightly lower in the long-run.
- Inflation expectations also came down for 2018 and 2019 to 1.9%, from 2.1% and 2.0% respectively. PCE through October was 2.0% and core PCE was 1.8%, so these projections align more closely with the current conditions, which have been remarkably stable. Given the recent drop in oil prices, there are few reasons to question the Fed’s confidence in low and stable inflation in the medium term.
- In its interest rate projections, the FOMC were more dovish. Investors should expect two rate hikes in 2019, as noted by Fed Chairman Jay Powell, who said they "now think it is more likely the economy will grow in a way that calls for two rate increases next year." Federal funds rate projections came down for the future, dropping to 3.1% from 3.4% in 2020 and 2021, and down to 2.8% from 3.0% in the long-run. This adjustment reflects fewer anticipated rate hikes.
- Finally, the interest rate on excess reserves was raised by 20 basis points to 2.4%, just under the higher bound of the federal funds target range. By raising this rate by only 20 basis points rather than 25 basis points, this effectively narrows the range of the federal funds rate. This rate was last adjusted this summer.
While equity markets initially reacted negatively to the Fed’s actions, their caution and flexible policy approach combined with a lack of inflation pressures this late in the economic expansion are both long-term positives for U.S. stocks.
EXHIBIT 1: FOMC SEPTEMBER 2018 FORECASTS
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