Fed: Slower pace of monetary tightening? - Westpac

Devin Lawrence
December 1, 2018

While he didn't comment directly on which way the Fed is leaning as far as December's meeting is concerned, market watchers zeroed in on his comment that rates "remain just below the broad range of estimates of the level that would be neutral for the economy".

The change comes months after Powell indicated plans to raise interest rates and cool down the U.S. economy, moves that run counter to President Donald Trump's expansionary moves, including last year's tax cuts. Rather, we assume that Powell wanted to prepare the markets for a change in the central bank's communication. Fed officials next meet December 18-19, and futures traders are pricing in a more than 70% probability of another quarter-point increase in the range for the key short-term rate, which would be the fourth hike of 2018.

US stocks had enjoyed a strong rally on Wednesday after Powell said USA interest rates were "just below" neutral, less than two months after saying rates were probably "a long way" from that point.

"His description highlights the significant uncertainty around estimates of neutral, a theme he mentioned at his speech at Jackson Hole in August", Jan Hatzius, chief U.S. economist for Goldman Sachs, wrote in a note to clients Wednesday.

Investors say a sustained market rally following the summit would hinge on there being substantive concessions from Trump, in particular whether Xi can persuade Trump to postpone a sharp tariff hike on Chinese goods due to take effect January 1.

Mr Powell's comments appear to implicitly reject arguments from President Trump that past interest rate rises have been a mistake. That suggested to many investors that fewer rate increases might be on the way.

The minutes from the rate-setting Federal Open Market Committee's November 7-8 meeting showed a rising level of uncertainty in the central bank about the near future. "This sounds like a more flexible approach to policy for 2019 than the impression created by the notion that the Fed has chose to lift the federal funds rate to neutral and that neutral was 3% or higher".

This week, a speech by Jerome Powell, the chairman of the US Federal Reserve, triggered strong price swings in financial markets.

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"Based on experience over recent years, such a regime was seen as providing good control of short-term money market rates in a variety of market conditions", the minutes said.

Powell has tried to delicately explain how the Fed is weighing future policy moves by using the analogy of walking into a pitch-black room filled with furniture. But that approach is no longer appropriate, Powell said.

"Given the volatility you've seen recently, it's probably quite reasonable to expect a little bit of a bounce. I think that's what we've been doing".

In a speech to the Economic Club of New York, Powell cautioned that while the economy is healthy now, "sound policymaking is as much about managing risks as it is about responding to the baseline forecast" - a warning that not hiking rates could have consequences down the road.

After the financial crisis erupted in 2008, the Fed kept rates at historically low levels to revive the ailing economy.

But policymakers may be divided over what to do after that, with some anxious that raising rates after December could "unduly slow" the American economy, just as signs of vulnerability are beginning to gather, the minutes showed. Three of those increases have been under Powell.

Paul Ashworth, chief USA economist at Capital Economics, said he expects two rate hikes in 2019, not the three the Fed has been projecting for next year.

"There is a great deal to like about this outlook", said Powell on Wednesday.

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