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Moderate Growth, Sluggish Inflation May Limit Fed’s Sidelined Position

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On January 31, 2020, Stifel’s Chief Economist, Lindsey Piegza, Ph.D., published Economic Commentary, excerpts from such publication are included below.

 

Moderate Growth, Sluggish Inflation May Limit Fed’s Sidelined Position

As expected, the Fed opted to keep policy unchanged in January after adding three rounds of additional accommodation in 2019.  Describing the economy as “moderate,” the Committee remains confident the current path of monetary policy remains “appropriate, at least for now.  The latest read on domestic activity, however, suggests underlying support may be faltering and furthermore, inflation may be cooling just as the Fed solidifies its commitment to reach a 2% price target.  While the market seems complacent, buying into the Fed’s more optimistic outlook for growth and inflation, policy makers will no doubt be pressured to take action to meet their elevated forecast if the economy continues to underperform.

 

Rates Unchanged as Economy Moderates

In the first policy announcement of the decade, the Fed, as expected, opted to leave rates unchanged in a range of 1.50% to 1.75%.  The interest paid on excess reserves, however, or the IOER, was raised by 5bps from 1.55% to 1.60%, a “technical” adjustment aimed to push the effective Fed funds rate closer to the middle of the target range.  As the Chairman explained during the press conference, last year there was some tightness as reserves drained out of the system, but now with “ample reserves it’s possible to again boost the interest rate on reserves.

Aside from a slight implementation adjustment, the Fed continues to judge the current policy position as the “appropriate” level to continue to “support sustained expansion of economic activity.”  The decision was unanimous with all 10 members of the Federal Open Market Committee voting in favor of maintaining the current target range for the Federal funds rate.

In describing the economy, the Committee maintains a relatively optimistic view of domestic activity, noting economic activity remains “moderate” amid “solid” job gains and "moderate" household spending, juxtaposed with “weak” business investment and exports.  On the inflation front, the Committee continues to acknowledge the low level of prices, but offered no indication of reduced confidence in inflation “returning to" – as opposed to "near" – the FOMC’s target of 2% in the near-term.

 

Going forward, the Fed maintains a pledge to continue to assess incoming data in terms of determining the appropriate level of policy, an assessment, which the statement specified, will include indicators of inflation and growth, and increasingly important, “international developments.”  The latest January communication, however, made no mention of increased downside risks to the outlook; the statement did not mention corporate shutdowns or geo-political tensions, nor did it specify warnings of the deadly coronavirus. 

 

Moderate Growth, Weakness in the Details

Also last week, the latest GDP report confirms the Fed’s more moderate assessment of the economy.  According to the Bureau of Economic Analysis, the U.S. economy continued to bounce along at a 2% pace through year-end.  While still positive, the economy has slowed noticeably from a more robust 3.1% pace at the start of last year, although on an annualized basis, GDP increased 2.3% October to December, slightly above the 2.1% pace reported in Q3. 

At 2%, however, growth remains at the bare minimum level of output expected from a developed economy with previous recoveries posting average activity rate nearer 5% on a sustained basis.  Furthermore, the current 2.1% acceleration has only been achieved against a backdrop of massive government spending resulting in more than $1 trillion deficits and record low interest rates.  With such stimulative conditions in place for some time, the return would be expectedly more robust, yet mediocrity seems to be sufficient to warrant marketplace exuberance.   

 

 

Renewed Commitment for Higher Prices May Force Fed’s Hand

End of the year growth was as expected, showing the U.S. economy remains in positive, albeit modest, territory at 2% GDP.  While nothing to sneeze at, the latest read on domestic activity confirms a noticeable loss of momentum from the start of last year, and furthermore, marks the bare minimum of activity expected from a developed economy. Additionally, a 2% growth rate appears increasingly unimpressive amid an environment of record low interest rates and massive government spending.

The Committee also remains convinced the current stance of monetary policy is well positioned to foster a return of inflation back to the Fed’s 2% target.  The latest PCE reading, however, rose just 1.4% in the fourth quarter, markedly less than the 1.8% gain expected, and a three-quarter low.  During the press conference the Chairman expounded on the Committee’s decision to adjust the language in the January FOMC statement regarding meeting as opposed to nearing the Fed’s inflation target.  We wanted to send “a clearer signal,” Powell explained, that the Committee was not comfortable with inflation running persistently below target. “We wanted to underscore our commitment to 2% not being a ceiling,” he said. 

While the Chairman may have intended to inspire confidence in the Fed’s commitment to pushing inflation back to the Committee’s symmetric objective, the lack of realized improvement in prices suggests the Fed’s perspective and reality may be at odds.  Furthermore, the lack of inflationary pressures – like a miss in topline growth – may soon become problematic for the Fed’s preferred position along the sidelines.  In other words, if the Committee is expected to be taken at its word, the Fed is going to have to act sooner than later to achieve its stronger growth and inflation goals.

 

Stifel Update

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