The Federal Reserve (Fed) has lowered its projections for US growth and inflation and reduced its expectations for interest rates. The “dot plot” published after last night’s meeting shows no rate hikes this year and only one in 2020.
Tighter financial conditions
At his press conference, Fed chair Jerome Powell said growth was slowing by more than expected amid tighter financial conditions. Although interest rates did not change, the Fed announced that it would stabilise its balance sheet in October, some three months earlier than previously expected.
This would seem to complete the Fed’s move from hawks in December to doves in March. Certainly the data has been soft with current estimates for Q1 GDP growth from the Federal Reserve Bank of Atlanta running at just 0.4% annualised. The Federal Open Market Committee (FOMC) statement highlighted the slowdown in household spending and business fixed investment alongside slower payroll growth.
A re-appraisal of the neutral rate for interest rates?
However, the latest move suggests there has been a more fundamental shift in the committee’s thinking. There was a significant reduction in the median projection for the Fed funds rate from 2.9% to 2.4% this year and from 3.1% to 2.6% by the end of next year. The reduction is greater than the fall in growth and core inflation projections combined and suggests a reappraisal of the neutral rate for the economy.
External factors are probably playing a role here and chair Powell mentioned the slowdown in international trade and Brexit, but the most likely factor has been the behaviour of inflation. Headline inflation has declined as a result of lower oil prices and core inflation has stabilised near the 2% target. Despite the late stage of the cycle, inflation is not a threat to the FOMC’s objectives and market expectations remain low.
Schroders now expects no further rate rises this year
We still expect the US economy to rebound in the second quarter as much of the current slowdown reflects a temporary move in inventory and we expect GDP growth to be stronger than the Fed forecasts this year.
Nonetheless, inflation is undershooting and with growth likely to slow toward the end of the year the window of opportunity for another rate hike is narrowing. Consequently, we are taking out our June rate increase and now see no further rate rises from the Fed this year. The next move is now likely to be a cut in 2020 as activity cools.
This article was previously published by Schroders on 21st March 2019.