As expected, the Federal Open Market Committee left short-term interest rates unchanged and provided some details on the unwinding of the balance sheet. The revised dot plot showed that a majority of senior Fed officials expect no change in rates in 2019 (but a majority also anticipate one or more hikes in 2020). In contrast, the federal funds futures market ended the week pricing in more than an even chance of at least one rate cut by the end of the year. It’s not unusual for the market’s expectations and the Fed’s expectations to differ. However, the fear that we saw at the start of the year may be back. The baseline scenario is for the economic expansion to continue, but the downside risks are what matter for investors.
Estimate of 2019 GDP growth have declined. The median forecast of senior Fed officials has tracked the general expectations of economists over time. Last September, Fed officials were expecting 2.5% growth this year (4Q19/4Q18) – expectations fell to 2.3% in December and to 2.1% in March (and that may prove to be a little optimistic). In its policy statement, the FOMC acknowledged softness in consumer spending and business fixed investment. However, subpar first quarter growth is not unusual. The Bureau of Economic Analysis has worked to reduce residual seasonality in the GDP data, but first quarter figures in recent years still tend to be below the growth rates of the other three quarters. While consumer spending numbers were unusually weak in December and only partially rebounded in January, the fundamentals of the household sector (job gains, wage growth, purchasing power, and consumer sentiment) appear sound. At the same time, we know that conditions vary considerably across the income scale. Business fixed investment was supported by the corporate tax cut in 2018, but slower global growth and trade policy uncertainty are negatives in 2019.
In his post-FOMC press conference, Fed Chairman Powell presented a positive outlook but also noted that growth was supported by the tailwinds of fiscal stimulus and strong global growth in 2018. Financial conditions “tightened considerably” in the fourth quarter, but “while conditions have eased since then, they remain less supportive of growth that during most of 2018.” While the federal funds target rate is at the bottom of the range of estimates of the neutral rate (the rate consistent with sustainable growth and stable inflation), most Fed officials believe the natural rate is a bit higher than it is now. However, signs of slower near-term growth, “muted” inflation, and the downside risks from Brexit and trade negotiations allow the Fed to be patient in deciding its next move. Still, by all indications, the Fed is on hold. Officials aren’t talking about cutting rates. In contrast, the federal funds futures market is pricing in a rate cut by the end of this year.
Fed officials expect the unemployment rate to edge a little lower this year, but then stabilize. That’s consistent with economic growth near a sustainable pace. However, the unemployment rate tends to either move higher or lower over time – it rarely trends flat. One often hears that the job market lags the economic cycle. To be clear, the unemployment rate is a lagging economic indicator, nonfarm payrolls are a coincident indicator, and weekly jobless claims are a leading indicator.