As widely expected, the Fed decided to hold rates steady coming out of its policy meeting. Investors aren’t watching to confirm that outcome, but to gain additional insight into the thinking inside the FOMC.
Given the negative market reaction to Fed Chairman Jerome Powell’s October comment that interest rates were “a long way from neutral”, the central bank has seemingly been intent on softening that message, while trimming its 2019 rate hike forecast in December.
As a result, the central bank’s apparent attempts to mend fences continues with today’s statement, backing away from “further gradual increases” in rates, and instead emphasized being patient in its assessment of the need for additional tightening.
In addition, the Fed addressed the other elephant in the room related to the continued runoff of its balance sheet, sending a clear message that the balance sheet runoff isn’t simply on autopilot, and they stand ready to make adjustments as needed in response to economic developments.
If we are to take the Fed at its word, which seems like a reasonable expectation, the central bank still anticipates raising its short-term policy rate an additional two times before the end of 2019. If they follow through, that would take the funds rate to a range of 2.75-3.0%, roughly in line with the central bank’s estimate of the neutral rate – in theory, moving policy from accommodative to neutral as well for the first time in over a decade.
Still, the capital markets remain skeptical, with Fed funds futures still pricing in roughly a 70% probability that policymakers won’t raise rates even once this year.
The bottom line is that there is still a distinct disconnect between the Fed’s forecast and investor expectations that will be resolved in one of a few ways. The question will be whether or not the current slowdown in growth overshoots policymakers expectations and requires them to adopt an even more dovish stance, or if the recent downturn in investor sentiment proves to be overly pessimistic.
It’s clear that the Fed is trying to do its part to alleviate those concerns.
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