Fed minutes: The Fed back-pedals

The minutes of the last Federal Open Market Committee meeting held on 8 November 2018, which were published yesterday evening, revealed surprising news about the direction of the Fed’s monetary policy going forward. Although the minutes left us in no doubt that the US central bank will raise the key rate corridor by another 25 basis points in December, what was new was the intention of the FOMC to change the language used. Whereas it was previously indicated that a gradual increase in the federal funds rate was adequate, it could soon be communicated that further key rate hikes will be made strictly contingent on incoming data releases.

Fed chairman Jerome Powell pointed out only a few weeks ago that the Fed was weighing up a slightly restrictive fed funds rate. Many market participants had therefore gained the impression in recent months that a 25 basis point increase every quarter was set in stone for the foreseeable future. The latest minutes challenged these expectations. A more flexible rhetoric is understandable, given that no one can say with absolute certainty where exactly the neutral rate lies. The previous key rate hikes are likely to have coincided with a less expansionary monetary policy. Now that the Fed is approaching the (broad) range of almost neutral monetary policy, uncertainty is growing about the economic effects of consistent monetary policy tightening. The central bank clearly does not want to be held responsible for potentially weaker economic growth. It is also uncertain at what pace the previous key rate hikes will impact on the economy. The Fed now wants to take account of this uncertainty by changing its rhetoric in the next FOMC minutes, which will be published after the 19 December meeting.

As we see it, however, this change does not signal an end to any further interest rate increases by the Fed in the months ahead. It merely attests the fact that the US central bank may also take a longer break in the rate tightening cycle, so as to observe the impact of previous monetary policy tightening. The minutes are therefore largely consistent with our expectations vis-a-vis US monetary policy in 2019 and our anticipation of overall sound economic growth next year. We expect the current pressure on wages to translate into slightly higher core inflation rates during the year. In light of this, fundamental economic data in the first half of the year will indicate a continuation of the rate-tightening cycle. We anticipate another two interest rate hikes in the first six months of 2019. However, if the Fed comes even close to a neutral rate, further monetary policy tightening is likely to be increasingly questioned. We therefore expect a break in the rate tightening cycle in the second half of the year. If the economic recovery remains robust towards the end of 2019, the Fed will probably tighten the monetary policy reins once more in December 2019. Nonetheless, the prospects of a somewhat more moderate interest rate policy have increased recently.

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