As the June FOMC meeting approached, pundits and market participants increasingly expected the Committee to raise rates.
This expectation was realized, as the FOMC raised the target range for the federal funds rate by 25 basis points. Since the FOMC had no new information on GDP, this was a decision that was clearly rooted in the context of a tight labor market and its implications for inflation down the road. Markets have interpreted this move, reinforced by the increase in the median funds rate projection for 2018 from three to four moves, as shifting from an accommodative to a more restrictive policy. There is much to glean from Chairman Powell’s press conference. For example, he announced that the Committee would begin holding a press conference after every meeting but would still prepare SEP forecasts only every other meeting. Before commenting on the press conference, however, let us look at some of the significant changes and potential inconsistencies in the press release.
After describing the continued improvement in labor markets, the statement goes on to characterize economic activity as “rising at a solid rate” and household spending as having picked up. Interestingly, in the Beige Book, only the Federal Reserve Bank of Dallas characterized district growth as solid, while four district banks said growth was modest, and seven said growth was moderate. Additionally, the Beige Book described consumer spending as “soft.” Not one of the district bank descriptions used the word solid, but rather said spending increased “slightly,” “modestly,” “moderately,” or was “mixed.” One wonders if the economy changed between the preparation of the Beige Book and the meeting or whether the descriptions were designed to bolster the policy move.
The major change in the post-meeting press release was deletion of its previous forward-guidance language that stated that the Committee’s policy rate would “remain, for some time, below levels that are expected to prevail in the longer run.” This omission was part of the reason that markets concluded that policy accommodation would be moving toward financial restraint, and this was abruptly reflected in an upward movement in interest rates along the curve.
As for the Summary of Economic Projections (SEPs), median GDP growth was moved up one tenth of a percent in 2018 and was unchanged in 2019 through the Longer Run. The unemployment forecast edged down even further to 3.5% in 2019 and 2020 but remained at 4.5% for the longer run. Finally, inflation, edged up slightly for 2019 and 2020, with the median funds rate now moving up steadily from 2.4% in 2018 to 3.4% in 2020. The anomaly in these SEP forecasts, as we have noted in previous commentaries, is the increase in the Longer Run in the unemployment rate to 4.5% with a drop in the median funds rate by half a percentage point to 2.9%. What might the committee expect to happen to generate this result? Is this an admission that the described policy path for the funds rate risks an overshoot and may cause a recession? When asked about this at the press conference, Chairman Powell simply stated that the figure was just an estimate and could change, but he offered no clues as to precisely what the Committee anticipates or why.
Turning to the press conference itself, there were several takeaways and uses of key words that warrant comment:
Persistent – This word was used in describing the FOMC’s 2% inflation target and the fact that the FOMC endeavors to avoid persistent deviations from that target. What was not explained, however, was how long and how large a deviation would have to be in order to be considered a persistent deviation that requires policy action. Uncertainty – Chairman Powell used the word uncertainty in several contexts, but most revealing was his use of that term when discussing the Committee’s Longer Run unemployment forecast. He clearly viewed that projection as an estimate of the so-called natural rate of unemployment consistent with stable prices. When pushed as to why the 4.5% Longer Rate isn’t closer to the 3.5% value for 2020, he said that it very well might be and that there is a range of uncertainty around that estimate, on the order of plus or minus .75 to 1 percentage points.
Unobservables – Closely related to his discussion of the natural rate of unemployment was his caution that one had to be careful in becoming too attached to estimates of economic variables, like the natural rate, that cannot be observed. The range of “uncertainty” around such values calls for caution when making policy.
Cushion – Powell was asked if one of the motivations for increasing rates was the desire to create an additional cushion so that the FOMC would be able to lower rates should that be necessary. He emphatically said that he did not consider that factor in his decision-making framework. He went on to argue that pursuing a cushion strategy held the risk of overshooting and even causing a downturn. He preferred a strategy of proceeding slowly to avoid overreaction.
So, in summary, Chairman Powell continued on his quest, quite successfully, to communicate with the public in plain English. He conveyed a view that was less “hawkish” than a cursory reading of the statement might suggest. Furthermore, he tried to downplay the significance of the adjustments that were made to the SEP forecasts. Finally, when pushed, he said the Committee was not yet ready to declare victory when it came to its inflation objective.
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