Keen readers noticed a wording change in the FOMC’s post-meeting statement. In its past communications, the FOMC indicated it would “act as appropriate to sustain the expansion.” The October statement, however, reported the committee would “monitor…incoming information…as it assesses the appropriate path of the target range for the federal funds rate.” The softer word choice of “assessing” instead of “acting” is key. Fed Chair Jerome Powell was less nuanced in his remarks after the meeting, saying monetary policy is “in a good place.”
The need for rate cuts has been the topic of much discussion, not least among the FOMC members themselves. Each decision to cut has come with dissents. The September dot plot, which charts committee members’ opinions of the appropriate level of near- and long-term rates, showed no member advocated for a prolonged cutting cycle. Roughly half the committee indicated one more cut in 2019 was appropriate, and that cut has been delivered.
The Fed’s hesitation to cut further is understandable. The economy continues to grow. The central bank’s mandate is to maintain stable prices and maximize employment. On the latter front, the economy is outperforming. The unemployment rate has held low levels of 4% or less for nearly two years. Job creation in October’s report exceeded expectations, and the labor force participation rate reached a cycle high. We see no indicators of a weakening labor market: new jobless claims are steady, hiring rates have yet to fall and wage growth continues.
Inflation has been more challenging. The Fed has chosen a target of 2% annual growth in the core personal consumption price index, which excludes volatile food and energy prices. The target is meant to be symmetric, with the actual rate moving both above and below the target. In reality, though, 2% has been the effective maximum rate observed in this cycle; inflation has rarely exceeded this level.
A confluence of factors is holding down inflation. Automation is making workers more productive; e-commerce enables comparisons that keep prices in check; inflation rates in the healthcare and higher education sectors are starting to cool. Moderate inflation is not necessarily a problem: businesses benefit from steady prices, while people living on fixed incomes will not see the value of their savings inflated away. And, as Kansas City Fed President Esther George said in recent comments, the average person isn’t concerned with slight changes to inflation rates.
Other policymakers have reason for worry, though. If inflation isn’t running above target under today’s circumstances of low unemployment and steady growth, the target may never be achievable. When the economy cools, the risk of deflation becomes more pronounced.
When discussing the current rate cuts, Fed Chair Jerome Powell has made reference to the “mid-cycle adjustments” of 1995 and 1998. In those years, the Fed cut rates slightly when the economy showed signs of slowing, in order to sustain the expansion. Just like today, there was a confluence of events that made markets nervous at the time, such as Russia’s sovereign default. The economy pulled through, and the Fed’s easing likely helped. But the parallel to today is stretched. Interest rates in the 1990s were higher. A reduction of 75 basis points was a relatively small step from a starting point of 6%, but from the current cycle’s peak of 2.5% is a substantial use of ammunition.
We expect the Fed to hold the federal funds rate steady over the year ahead. Powell did not preclude further cuts, but we predict they would have to be prompted by a severe deterioration of economic data. Meanwhile, studying past insurance cuts leads to an obvious question: Once markets normalize, will the Fed raise rates, as we saw in 1997 and 1999? Powell was clear in this answer: The FOMC will only consider a rate hike after inflation returns above its 2% target. Though inflation is recovering, it will take time to build to a sustained run above 2%.
This week’s report of third quarter U.S. gross domestic product (GDP) growth reinforces the Fed’s case to pause. As it was in the second quarter, real consumer spending was the brightest point in the data, growing by 2.9% at an annualized rate. Encouragingly, after a six-quarter decline, residential investment picked up, suggesting the Fed’s lower rates are working to support rate-sensitive sectors. Business investment continued to decline, but the factors weighing on business sentiment, like trade uncertainty and a global slowdown, are beyond the Fed’s influence.