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Fed Expected to Hold Rates Steady and Emphasize Patience Fed Signals End of Interest Rate Increases
(about 9 hours later)
WASHINGTON — The Federal Reserve has adopted a new theme for the new year: patience. WASHINGTON — The Federal Reserve signaled Wednesday that it may be done raising interest rates.
It is not expected to announce any change in its benchmark interest rate on Wednesday, after its first policymaking meeting of 2019. The Fed’s chairman, Jerome H. Powell, is expected to emphasize that the Fed will take time to evaluate economic conditions before considering any more rate increases. In a statement following a two-day meeting of its policymaking committee, the Fed said that economic growth remained “solid,” and that it expected growth to continue.
The recently concluded five-week shutdown of the federal government fogged the Fed’s windshield, reducing the availability of up-to-date economic data. But Fed officials and many outside economists do not expect the shutdown to leave a significant lasting mark on the economy. But in a sharp reversal of its stance just one month ago, the Fed did not say it expected to keep raising interest rates. Instead, the statement said the Fed would be “patient” in evaluating the health of the economy. And it indicated that the Fed stood ready either to increase or to reduce rates, depending on economic conditions.
Instead, the Fed’s focus is on other signs that economic growth may be slowing, including the weakness of the global economy and the volatility in financial markets. Inflation also remains below the Fed’s 2 percent target. That could be another sign of weakness, and it leaves the Fed with little reason to raise rates again right now. Reinforcing this cautious tone, the Fed also announced that it stood ready to slow or even reverse the steady slimming of its bond portfolio. This, too, marked a striking shift. The Fed in December said it was committed to reducing its holdings of Treasurys and mortgage bonds, which it amassed during the financial crisis to help bolster the economy, at a steady pace.
But Mr. Powell and other Fed officials have repeatedly predicted that the economy will continue to grow this year, and they have insisted that they might continue to raise interest rates later on. The Fed’s policymaking committee voted unanimously for the changes.
“We have the ability to be patient and watch patiently and carefully as we watch the economy evolve,” Mr. Powell said this month. The voices of other Fed officials in recent weeks have harmonized on the same theme with unusual fidelity, leaving little doubt of the Fed’s intentions. Stock markets, which were up even before the Fed decision hit at 2 p.m., climbed more after the arrival of the statement. At around 2:15 p.m., the S&P 500 was up more than 1.4 percent. Yields on shorter-term Treasury securities declined, as traders bet that future rate hikes would be pushed further out.
The Fed has raised its benchmark interest rate in five consecutive quarters. The most recent increase, in December, moved the rate into a range between 2.25 percent and 2.5 percent. The Fed’s newfound caution is likely to delight President Trump, who argued loudly and publicly through much of 2018 that the Fed should stop raising its benchmark rate, which now sits in a range between 2.25 and 2.5 percent. Many liberal economists also argued for the Fed to take a break.
In December, most Fed officials predicted the Fed would raise rates at least two more times in 2019. The unemployment rate remains low by historical standards, but inflation has been sluggish for the entirety of the last decade — and the Fed’s statement noted market-based measures of inflation expectations have weakened in recent months.
Michael Feroli, the chief United States economist at JPMorgan Chase, wrote in a preview of the January meeting that he expected the Fed to make clear that any rate increases in 2019 would depend on the strength of the economy. “At the same time,” he wrote, “we think they will try to avoid giving the impression that pause equals stop, or that the economic outlook has materially downshifted.” The statement also referred to the weakness of global growth and volatility in a range of financial markets.
A major focus of the January meeting is likely to be on the mechanics of monetary policy. “In light of global economic and financial developments and muted inflation pressures, the committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate,” the statement said.
After the financial crisis, the Fed changed the way it moves interest rates, and it must decide whether to keep the new system in place or return to the precrisis system. The Fed issued a second statement about its balance sheet.
Investors are watching that decision closely because it will determine how much money the Fed keeps in the bond market. The Fed amassed more than $4 trillion in Treasury securities and mortgage bonds in the wake of the financial crisis, as part of its broader campaign to revive economic activity by reducing borrowing costs. Since the fall of 2017, the Fed has gradually reduced those holdings, currently at a pace of about $45 billion per month.
Under either system, the Fed plans to reduce its holdings of Treasuries and mortgage bonds, which it acquired as part of its campaign to stimulate economic growth after the 2008 crisis. It is reducing its more than $4 trillion portfolio at a slow and steady pace, shaving about $45 billion every month. Markets have blamed the recent volatility on the Fed’s balance sheet runoff, saying it was causing investors to dump riskier assets like stocks and corporate bonds and snap up safer Treasurys and mortgage securities. The Fed’s bond-buying program, known as quantitative easing, tried to goose the economy by holding down long-term interest rates and encouraging investors to buy riskier investments.
Under the new system, however, the Fed would stop selling bonds sooner and retain a larger portfolio. On Wednesday, the Fed indicated it could change the pace and path of its portfolio reduction and keep more money in the bond market if necessary.
“The committee is prepared to adjust any of the details for completing the balance sheet normalization in light of economic and financial developments,” the statement said. It added the Fed also stood willing to increase the size of the balance sheet, if necessary.
The decision has limited implications for the general public. Some Fed officials and outside experts think that the new approach has improved the Fed’s ability to influence economic conditions, but the practical difference is generally regarded as modest.The decision has limited implications for the general public. Some Fed officials and outside experts think that the new approach has improved the Fed’s ability to influence economic conditions, but the practical difference is generally regarded as modest.
Some investors also argue that the Fed should reduce the pace of its retreat because the diminution of its holdings is contributing to volatility in financial markets. The Fed, and a number of outside analysts, have dismissed these concerns as baseless. Seeking to soothe markets, however, Fed officials have also said they are willing to slow the pace if they see convincing evidence of problems.
Before the financial crisis, the Fed influenced economic conditions by adjusting the quantity of reserves in the banking system. Banks are required to hold reserves in proportion to deposits, so constraining the supply forced banks to compete for the available reserves by paying higher interest rates. That, in turn, caused banks to raise interest rates on loans.
During the crisis, the Fed pumped enough reserves into the banking system to cut short-term interest rates nearly to zero. Then it continued to pump reserves into the system, purchasing Treasuries and mortgage bonds to bring down long-term rates.
The result is a system still awash in reserves.
Since 2015, the Fed has gradually raised short-term rates by simulating a scarcity of reserves: It pays banks to leave the extra money untouched.
A number of Fed officials, including Mr. Powell, have indicated they prefer the new mechanics, suggesting the Fed is likely to maintain excess reserves in the banking system. To do so, some analysts project it would need to stop reducing the size of its bond holdings as soon as the second half of 2019.
That is creating a communications problem for the central bank. Investors have tended to treat decisions about its bond holdings as evidence about its economic outlook, and about its plans for short-term rates.
Mr. Powell has tried to convince investors that decisions about the balance sheet are technical in nature, and were unrelated to the Fed’s plans for interest rates. Tim Duy, an economist at the University of Oregon who follows the Fed closely, predicted Mr. Powell would renew that attempt on Wednesday.
“Good luck with that though,” Mr. Duy said. “I suspect that any indication that the Fed is winding down quantitative easing will be read as a dovish signal,” meaning that markets would interpret the decision as suggesting the Fed is less likely to raise rates.