We no longer expect a hike in June. We previously took out our expectation of a hike in March, but the reasons for taking out the March and June hikes are quite different. With respect to the March hike, the story is not a change in the baseline forecast, but elevated downside risks that called for a risk-management, wait-and-see posture. With respect to June and beyond, the driver of our call is not risk management, but rather a reassessment of what appropriate policy is given the baseline forecast.
Powell focused on the “cross-currents” in the economy. On the one hand, the economy has been growing strongly and the unemployment rate is already very low. And the economy is expected to continue to grow at an above-trend, though slower, rate this year. On the other hand, there are a number of asymmetric downside risks, and inflation has been tame. We have called this backward-looking strength and forward
looking angst. The latter calls for risk management in the form of patience to allow time to see how the risks are resolved. In this case, and with respect to March, “patience” means “pause,” in the sense of delaying a hike that otherwise might have seemed appropriate.
But what is more important in our view with respect to the period beyond June is a reassessment of what appropriate policy is in the context of the baseline forecast. This reassessment reflects recognition of the key features of the outlook that will drive monetary policy. First, growth is expected to slow sharply this year— the effect of past tightening and the lack of a substantial boost from fiscal stimulus like there was last year— and over the remainder of the forecast horizon—indeed, from well above trend to below trend. This is reflected in our respective forecasts as a bottoming in the unemployment rate in late 2019 and a modest rise thereafter. This has all been part of our forecast for some time. The second feature, which was strongly emphasized by Powell is, of course, muted inflation.
In explaining the FOMC’s thinking, Powell asked, “Why do central banks tighten?” A primary reason is to move preemptively against the threat of higher inflation—in this case, unacceptably higher. But the baseline forecast does not appear to call for a preemptive move to restrictive territory—or even a rise within the broad range of neutral. Of course, the inflation data could pick up and change this. But we see the monthly pattern as more likely to show a 12-month rate for core PCE inflation modestly below 2% into the second half of this year. Unlike FOMC participants, we have seen the potential for a very modest overshoot of the inflation objective by 2021. But too far away to take seriously in 2019, and too small to change our call.
The FOMC put a priority on removing accommodation in 2018. With the emphasis, today on uncertainty about r-star and the focus instead on a broad range of neutral, the hikes in 2018 in Powell’s view have brought the funds rate to at least the edge of neutral. Now at the edge of neutral, and given the forecast of slowing growth and muted inflation, there is no longer a presumption that the next move will be a hike. The statement now talks about “adjustments” rather than “increases.”
Having said that, there’s still some probability of a hike in 2019, and we continue to see a hike as more likely than a cut this year. After this year, however, we see a cut as more likely than a hike. We have been saying
that the window for further hikes would be closing rapidly in the second half of this year because the slowdown would be more clearly visible, the unemployment rate would be expected to rise the next year, and, of course, inflation would likely still be muted. We still think that story holds. For that reason, we have simply not been able to understand why the FOMC could continue to see a rate hike as appropriate in 2020, after just two in 2019, when they predicted that the unemployment rate would begin to edge up that year and continue to rise in 2021. We will make the call that the March dots will not show this anomaly of a 2020 hike!
In 2019, the FOMC’s priority is to keep the expansion going. There is little fear of an unacceptably large inflation overshoot, and the fear of runaway inflation is completely absent. Priorities in this respect are history-dependent. The fact that inflation has averaged below 2% over many years makes the FOMC more tolerant of a modest overshoot. And the memory of the Great Recession puts a priority on keeping the expansion going. Importantly, the proximity of the effective lower bound calls for more preemptive policy with respect to easing, as compared to tightening.