From a “Long Way from Neutral” to “Just Below the Broad Range” of Neutral Estimates

In an interview on October 3, Powell described the fund’s rate as being a “long way from neutral.” Several days after that equity prices began to fall sharply, and by the next week had fallen about 7%. It’s certainly unfair to simply pin the blame for the decline in equity prices on the Fed, but it’s clear that Powell’s October  3 remarks were interpreted as hawkish, reflected in a six-basis-point rise in the two-year yield that day. In his speech on November 28, he precipitated a rally when he said the fund’s rate was “just below” the “broad range” of estimates of neutral. The October language was seen by the markets as signaling more rate hikes ahead than anticipated, the second as signaling fewer hikes. 

Let me admit at the beginning that my approach might be seen as “Talmudic,” in that I am scrutinizing every word, as Talmudic scholars did, again and again, over the ages. But, we have always emphasized, with respect to the Fed, that every word matters! 

The move from “neutral” to “broad range” of estimates of neutral was also more dovish. To be sure, Powell often talks about the range of estimates of neutral to emphasize, appropriately, the uncertainty about r-star.  Still, talking about the broad range of estimates of neutral suggests a range wider than the central tendency of FOMC participants, which is 2¾%-3%, with the median at 3%. Participants’ estimates are tightly clustered in that central tendency range, and that is why we have expected the FOMC to continue hiking at least through June. But Powell’s reference to a ”broad” range, perhaps 2½%-3%, would seem to put March more in play as the timing of the last hike before a pause.  

The changes from “a long way” to “just below” and from “neutral” to a “broad range” of neutral estimates appear to reinforce the dovish interpretation of Powell’s remarks. Were these changes intended to send a  more dovish signal? At the very least, I suspect Powell wanted to back away from the “long way” language.  Talking about a range of estimates of neutral rather than a point estimate is clearly more appropriate, given the views he has set out very clearly at Jackson Hole as well as in earlier remarks. To describe the range as  “broad” does go a step further though. 

A lot to consider as we head toward the December meeting. We have to reflect also on any changes in our forecast before that meeting as well as the incoming data. Financial conditions are somewhat tighter than we assumed in our last forecast and that could take a few tenths off the level of GDP by the end of 2020. But any change in the outlook for growth does not seem enough at this point to by itself change the fundamental story or rate call. There are other developments to consider as well, including that the core PCE inflation data has been softer than anticipated in recent months, though it’s not enough to reconsider our view that core inflation will remain close to its objective and move slightly above it in 2020 and 2021.  

While our call has been for three hikes in 2019—hikes at every other meeting through September 2019—we have emphasized that two hikes in 2019 are much more likely than four. On balance, the combination of  

possible forecast revisions and the change in the language by Powell makes us inclined to take away one hike next year in our base case. That would leave the funds rate at 2¾%-3% at the end of 2019, rather than 3% to 3¼%. With respect to the median of participants’ dots, we are also inclined to remove one hike, either from  2019 or 2020. 

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