As non-surprises go, the U.S. Federal Reserve’s policy announcement Wednesday was pretty surprising. Nobody should have been shocked by the headline: as expected, the Fed’s Federal Open Market Committee is holding the top range of its target federal funds rate steady at 2.5 per cent. And perhaps not many market-watchers were caught off guard by the fact that the FOMC in its statement and chair Jerome Powell in his news conference struck a generally more dovish tone this time around than at the last meeting, on Dec. 19, when it hiked rates and precipitated a bloodbath in equities. But whatwassurprising was the extent of the capitulation — and not just on the Fed’s not-so-long-ago commitment to stay on its hiking path.
On that note, consider where the Fed’s collective head was at just six short weeks back. In its December statement, the FOMC said “some further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s two per cent objective over the medium term.” On Wednesday, the tune changed: “In light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to (rates) may be appropriate.”
What happened, in the span of a month and a bit, to “further gradual increases? Well, there was that aforementioned December meltdown — part of what Powell characterized as tightening financial conditions — but also evidence of China slowing and Europe and Japan stalling; of heightened trade tensions inhibiting global growth; of political uncertainty, in the Brexit Isles and elsewhere; and, lest we forget, a partial U.S. government shutdown that could end up taking a big bite out of the world’s largest economy — though nobody knows how big, really, in part because staff at some of the government agencies that measure such things have been missing a lot of work lately.
So now the Fed has switched to “patient” mode. It’s a word with some history in Fed-speak, and therefore not to be taken lightly. Back in 2015, the policymaker under Powell’s predecessor, Janet Yellen, dropped “patient” from its description of how it would approach raising rates from the post-recession zero range after the March FOMC meeting — a foreshadowing of the beginning of the hiking cycle in December of that year. This year, the word has enjoyed a renaissance. Powell used it to describe the Fed’s monetary policy approach on Jan. 10, at a meeting of the Economic Club of Washington, D.C., and other Fed policymakers followed suit. That would suggest they really mean it. If this turns out to be merely a pause on the hiking cycle, it would be surprising if it turns out not to be a long one.
The Fed’s other surprise-by-degree — a separate statement on the path of balance sheet unwinding — supports the view that it might be patient for longer rather than shorter. In recent weeks, market commentary has focused on the Fed’s unwind of quantitative easing and the impact on credit markets and the yield curve. Again as recently as December, Powell had said quantitative tightening was on “auto pilot,” which markets didn’t like very much. This week’s statement, however, was a change of tune. Now, while the FOMC still holds that tinkering with rates will be its primary policy lever, it is “prepared to adjust any of the details for completing balance sheet normalization in light of economic and financial developments.” And that includes “altering the size and composition of its balance sheet, if future economic conditions were to warrant a more accommodative monetary policy than can be achieved solely by reducing the federal funds rate.”
In short, not necessarily quantitative easing, but quantitative easing if necessary.
Powell, in his news conference, said that the Fed has begun discussions on the “final stages” of the de-QE process, along with the appropriate level of assets the Fed should continue to hold to meet banks’ demands for reserves. But here’s the kicker: “Normalization of the size of the portfolio will be completed sooner and with a larger balance sheet than in previous estimates.” That might be a signal the experiment in unwinding the US$4.5 trillion in debt instruments the Fed amassed through its emergency bond-buying program could be reaching an end.
Investors seemed to take this change in tack as good news. A rate hold should be broadly supportive of equity valuations — and predictably, markets rallied on the announcement while, just as predictably, the U.S. dollar fell. The bad news, of course, is that the Fed’s back-stepping suggests that the economic cycle really might be getting long in the tooth, and that the recovery isn’t as robust as it previously let on. After all, those economic “cross-currents,” as Powell called them — trade wars, slowing and fractious Europe, China and Brexit, and so on — haven’t gone away.
But at least for now, the Fed’s new patience might make them easier for investors to withstand.