Following this week’s meeting of the Federal Open Market Committee (FOMC), the Fed issued a statement that more forcefully signaled its intention to be cautious in the face of a more uncertain outlook. Policymakers also signaled that they view the current stance of monetary policy as more or less neutral. Therefore, investors should expect the Fed to keep rates steady, for now.
We think the Fed is right to be cautious in the face of rising global economic risks along with uncertainties surrounding politics and policy. Amid only modest inflationary pressures and financial imbalances, a cautious approach is consistent with a balanced risk management strategy that should ultimately lengthen the economic cycle.
Consistent with this, markets have taken note of the Fed’s shift toward caution, and financial conditions have eased again after the significant tightening in late December. The decline in interest rates and recovery in equity prices should help assuage the risk that the U.S. economy slows more meaningfully in 2019.
Balance sheet as a policy tool
Further softening its tone, the Fed also reiterated that during a downturn, it would be prepared to use its full range of tools – including altering the size and composition of its balance sheet (e.g., via substantially more asset purchases or “quantitative easing”) – if a more accommodative monetary policy could not be achieved solely by reducing the fed funds rate.
Fed officials also confirmed that they will maintain the current floor system for setting monetary policy, in which the Fed relies on its administered rates to control a broader range of money market rates. This suggests that the process of shrinking the balance sheet could conclude by the end of 2019.
