Instant Analysis: FOMC signals prolonged rate hike pause into 2020
The FOMC all but gave up their dreams of normalizing short-term interest rates, deciding to hold the Fed fund target rate between 2.25% and 2.50% at today’s FOMC meeting with 11 FOMC participants expecting the Fed funds rate to end 2019 at the same levels.
Four participants still anticipated one hike this year, while two participants anticipate two hikes this year. The median FOMC projections on the Fed funds rate for 2020 and 2021 are at 2.6%, suggesting one more quarter-point rate hike in 2020 and then a permanent hold.
Notably, even if the FOMC does pull off one more quarter point hike over the next two years, it will still fall short of its estimate of a long-run Fed funds rate of 2.8%. Given today’s FOMC decision and interest rate outlook, we think the most likely path forward for the Fed is a prolonged pause into 2020 with the next move from the FOMC being a rate cut. We will be adjusting our interest rate forecasts for year-end 2019 somewhat lower to reflect this change in view, while keeping our Fed fund rate cut expectations intact for 2020.
The FOMC is also going to promptly start scaling-back their balance sheet normalization program. Starting in May, the Fed will begin tapering their Treasury runoff, reducing the current monthly cap of $30 billion to $15 billion. By the end of September, the Fed will officially end the reduction of their securities holdings in the System Open Market Account. However, overall bank reserves will continue to decline – all be it at a much more gradual rate. The Fed will continue to reduce their holdings of agency and agency MBS debt in their securities portfolio, replacing them with Treasury securities. Beginning in October 2019, the principle payments from agencies and agency MBS will be reinvested in Treasuries at a cap of $20 billion a month.
The FOMC downgraded their assessment of current U.S. economic conditions, noting slower growth in household spending and business fixed investment in Q1. However, their biggest concern today appears to be the global economic slowdown as growth in China and Europe continues to weaken, and downside risks from the U.S./China trade war and Brexit will likely linger well into 2019 and beyond.
The FOMC still described the U.S. labor market as solid, but that was a downgrade from a “strong” assessment back in December. They also cut their median forecasts for U.S. GDP growth for 2019 by two-tenths of a percentage point to 2.1% and by one-tenth of a percentage point for 2020 to 1.9%. They also raised their median forecast for the unemployment rate by two tenths in 2019 to 3.7%, and up by a tenth for 2020 and 2021 to end the period at 3.9%. Their forecast for core PCE inflation was unchanged at 2.0% over the next three years, but they reduced their median forecast for headline PCE inflation for 2019 to 1.8% due to lower energy prices.
Stocks finished the day mixed on the news with the S&P 500 dropping 0.3% and the Nasdaq managing a 0.07% gain. Treasuries finished the day sharply higher, with the Treasury yield curve seeing nearly a parallel move lower. Treasury yields between the 2 year and 10 year maturities all dropped between 7 and 10 basis points today. The Bloomberg U.S. dollar index dropped by 0.5% today on the lower U.S. interest rate and growth outlook.