WASHINGTON – The Federal Reserve is considered sure to leave its key short-term interest rate unchanged Wednesday and to stress its new watchword – “patient”– in conveying its intention to leave rates alone for the foreseeable future.
The Fed has made clear that with a dimmer economic picture in both the United States and globally, it no longer sees the need to keep raising rates as it did four times in 2018. Among the key factors, besides slower growth, are President Donald Trump’s trade war with China, continually low inflation levels and Prime Minister Theresa May’s struggle to execute Britain’s exit from the European Union.
Besides issuing a policy statement Wednesday, the Fed will update its forecasts for the economy and interest rates, and Chairman Jerome Powell will hold a news conference. Analysts will be looking for any fresh hints of how the Fed intends to manage its rate policies in the coming months.
The Fed’s meeting, which began Tuesday, will end Wednesday afternoon. Here are three things to watch for:
The Fed is set to leave its benchmark rate – which can influence everything from mortgages to credit cards to home equity lines of credit – unchanged in a range of 2.25 per cent to 2.5 per cent. But what about the rest of the year?
For that answer, analysts will be watching the so-called “dot plot.” This is an illustration in which each of the 17 members of the Fed’s interest rate committee provides his or her anonymous forecast of where their key policy rate will go. On Wednesday, the dots will show where the officials expect the rate to be at the end of 2019 and after each of the next two years. The median dot – where half are above, half below – is closely watched for the Fed’s view of where its key rate might be headed.
It isn’t always correct. In December 2017, for example, the Fed’s policymakers predicted four rate increases in 2018. That proved true. In September 2018, though, the Fed projected three rate hikes in 2019, only to reduce that prediction in December to two. And on Wednesday, many economists say they think the new dot plot will forecast just one rate increase this year.
Even that may overstate what the Fed will end up doing. Traders in futures markets have put the probability of a rate hike at any time this year at zero per cent, according to data tracked by the CME Group. In fact, the CME index projects a one-in-four chance that the Fed will go so far as to cut rates by year’s end to help fight an expected economic slowdown.
STOP SHRINKING BOND HOLDINGS?
One of the extraordinary programs the Fed deployed after the 2008 financial crisis to stabilize the economy was the purchase of billions in Treasury and mortgage bonds. The idea was that these bond purchases would help hold down long-term borrowing rates and thereby stimulate borrowing and spending.
It was called quantitative easing. And while it likely helped revive the economy, it also ended up swelling the Fed’s balance sheet more than four-fold, from under $1 trillion to a peak of $4.5 trillion. In October 2017, with the economy back on firm footing, the Fed began shrinking its portfolio by allowing some maturing bonds to roll off its balance sheet rather than being reinvested. As a result, the balance sheet is now down slightly to $4 trillion.
As this runoff from the Fed’s balance sheet has proceeded, investors have grown worried that the Fed could overdo the bond reductions and inadvertently cause long-term rates to surge. That would risk depressing economic growth as well as stock prices.
When Powell suggested at a news conference in December that the runoff from the Fed’s balance sheet was on “automatic pilot,” he alarmed investors, who began dumping stocks. Powell has since reversed course. He has increasingly stressed the Fed’s patience and flexibility toward all elements of its policymaking, from its benchmark rate to the runoff from its balance sheet, depending on how severe the economic risks appear. And the chairman has said that the reduction in its bond holdings will end soon, with a balance sheet probably no lower than around $3.5 trillion.
In recent appearances, Powell has said the Fed has been discussing a plan to end the runoff from its balance sheet. Many analysts think the Fed will specify Wednesday at what point this year it plans to halt the reduction in its bond holdings – something of keen interest to financial markets.
THE PACE OF GROWTH
The U.S. economy grew 2.9 per cent in 2018, its best showing since 2015, the government has estimated. President Donald Trump has hailed this achievement, and the budget plan he released last week projects sustained growth of 3 per cent or better for years to come.
But the Fed and most private forecasters think those estimates are far too optimistic. They have suggested that a slower-growing workforce, reflecting the retirement of America’s baby boomers, and tepid productivity gains, along with a weaker global economy, will depress growth. In December, the Fed forecast growth of 2.3 per cent this year, 2 per cent in 2020 and just 1.8 per cent in 2021.
Analysts will be watching the Fed’s updated forecasts to see whether it further downgrades its expectations for growth. Doing so would suggest that it has grown concerned about how a persistent global slowdown might dim the outlook for the United States as well.
Any significant markdown in expected growth might be a signal from the Fed of a major forthcoming shift in course: Under this scenario, the Fed might decide later this year not merely to keep rates where they are but to actually reduce them to ease borrowing rates and help sustain the economic expansion and avoid a recession.
Whether such a message would cheer or spook the markets, though, is anyone’s guess.