Monetary mayhem

J.P. Szafranski, BridgeTower Media Newswires

In a typical year, as the calendar turns toward late December, market news flow and trading activity usually ebb as the holidays approach. 2018 was no such typical year. I can count on one hand the number of U.S. Federal Reserve Open Market Committee meetings with any sense of suspense over the past decade.

Noteworthy market (and presidential tweet) volatility in the lead-up to the Fed’s Dec. 18 and 19 meeting added a great degree of intrigue to what Chairman Jerome Powell and his committee would say and do. This October, Powell said that despite having raised rates four times in the past year, the Fed was “a long way from neutral” monetary policy and might in fact go “past neutral” in order to keep inflation at bay. Neutral in this context is the theoretical Fed Funds rate that neither stimulates nor restricts economic growth.

Powell’s comments were perceived as too hawkish by many, including President Trump, and stock markets swooned. Mr. Trump said that Powell and the Fed were “going loco” and repeatedly urged the central bank to stop raising interest rates. Such public presidential pressure represents a departure from decades of deferential treatment afforded to the Fed chair as the central bank asserts independence from politics in pursuit of its congressional mandate to seek stable prices and full employment.

Market participants wondered if the president’s actions would affect the Fed decision. We doubt it. Moving past the political chaos, let’s review what the Fed said and did and what it means for markets and the economy.
In the months leading up to the December meeting, the Fed telegraphed its intention to raise rates by 0.25 percent. Would Chair Powell follow through while doubling down on his prior expectation for multiple rate increases in 2019, would he shift tack with a rate increase but signal a pause of further hikes until seeing economic data next year confirming that growth is still intact (financial media began calling this scenario a “dovish hike”), or perhaps even reverse course and keep rates unchanged at the meeting?

The Fed ultimately chose to raise rates by 0.25 percent, slightly soften its outlook for future economic growth in its Summary of Economic Projections and drop its median projection for 2019 quarter-point rate increases from three to two. Their official statement tried to assuage concerns from recent market turmoil, saying that they “will continue to monitor global economic and financial developments.”

However, during his post-meeting press conference Powell said that tightening financial conditions “have not fundamentally altered our outlook.” Powell’s press conference performance sent the Dow Jones Industrials down over 700 points. It’s often said that it’s not the Fed’s job to come to rescue of financial markets. We agree. But it is the Fed’s job to pay close attention to financial market signals that are extremely valuable, albeit volatile, indicators of the future prospects for the economy.

The Fed’s conundrum stems from conflicting messages in the data. Backward-looking data for growth and employment paint a picture of a robust economy, while forward-looking market data signals weakness ahead. It’s obvious to us that the Fed should assign much more emphasis to forward-looking indicators.

Bond, stock and commodity markets are all flashing warning signs. Despite the Fed’s own projection for two rate hikes in 2019, the Fed Funds Futures market now implies just a 14 percent chance for one and even a 12 percent chance for a rate cut. Stock market indices dropped around 20 percent from recent highs. Oil and copper prices are off close to 40 percent and 20 percent, respectively.

The Fed is done with interest rate hikes for now. They just haven’t realized it yet.

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J.P. Szafranski is CEO of Meliora Capital in Tulsa (www.melcapital.com).