Global Considerations
The Fed’s plans for monetary policy also have come under scrutiny given slower global growth outside the United States and continuing trade tensions. While Powell said the Fed hasn’t seen any significant evidence of tariffs at an “aggregate level,” he did note that the Fed has observed growing labor shortages, supply chain constraints, and added pressure on wages and input costs—all likely influenced by tariffs. Powell also noted the Fed is concerned with the intangible cooling effects, specifically from loss of business confidence, financial market reactions, and the uncertainty of significant escalation from current conditions. But the minimal impact seen to date on the overall economy is still the dominant point, likely due to much more significant offsets from fiscal policy. We side with the Fed here—we believe that the $350 billion tailwind from fiscal stimulus will continue to overpower headwinds from trade. However, the U.S.-China trade situation can escalate quickly, and with midterm elections coming up, we don’t expect an agreement any time soon.
Powell also touched on the Fed’s consideration of recent emerging market (EM) concerns in his comments. He noted that concerns with EM economies, or the global economy in general, are considered in light of their impact on the U.S. economy. Of course, the Fed has a domestic mandate, but we consider global stability the Fed’s unofficial third mandate given the interconnected nature of international economies. The Fed’s tightening path may put further pressure on EM economies, as these countries owe about $4.5 trillion in U.S. dollar-denominated debt, and a rising dollar makes it increasingly difficult for these economies to service that debt.
Conclusion
Overall, the Fed’s dots and Powell’s comments point towards a gradual, but slowing pace of rate hikes as monetary policy moves closer to a neutral stance. According to the Fed’s projections, policy is about four rate hikes away from a neutral rate. However, we think the Fed has several factors to consider when deciding on future monetary policy, and any change in these crosswinds could make it more difficult for the Fed to continue its pace of tightening.
Nevertheless, we remain confident that Powell’s pragmatic approach to evaluating these crosswinds will limit the Fed’s chances of making a policy mistake.
John Lynch is chief investment strategist for LPL Financial.