US Monetary Policy: Pragmatism As New Guidance

US monetary policy: pragmatism as new guidancethe Fed has already prepared the markets for a pragmatic, data-dependent stance going forward

For financial markets, it has become a foregone conclusion that the US Federal Reserve will raise its federal funds target rate on Wednesday for the fourth time this year, by 25 basis points (i.e. between 2.25% and 2.50%). As this will be no surprise, market participants will rather focus on what to expect from the Fed going forward. 

For experts at Julius Baer, an “important clue” for guidance has so far been the projections of the individual members of the Federal Open Market Committee (FOMC), which determines monetary policy, and thus federal funds rate levels. However, Fed Chairman Jerome Powell made it quite clear in his speech at the Economic Club of New York on 28 November that, while interest rate levels may be currently low by historical standards, “they just remain below the broad range of estimates of the level that would be neutral for the economy”. Furthermore, Fed Vice Chairman Randal Quarles stated recently, “The more the federal funds rate approaches this [unobservable] neutral rate, the less it becomes useful for policy”.

In addition, Powell emphasised in his New York speech that “there is no preset policy path” for the Fed now, but that it pays “very close attention to what incoming economic and financial data are telling”. Thus, the Fed has already prepared the markets for a pragmatic, data-dependent stance going forward, which significantly reduces the importance that the ‘dots’ have had so far.

Despite a booming US economy, driven by strong consumption, the latest Fed-relevant Personal Consumption Expenditure (PCE) inflation data shows headline annual figures receding to around 2%, which equals the Fed’s so-called ‘comfort zone’, while the core PCE rate has even dropped to 1.8%. Therefore, economists at the firm could imagine the updated FOMC ‘dots’ to signal at most only two possible federal funds rate hikes of 25 basis points for 2019, instead of the current three as of last September, sticking to one hike in 2020. Markets currently foresee only a 15 basis point higher federal funds rate in 2019 than at the end of 2018.

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