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Fed Holds Steady; Patient Approach to Continue

Key Points
  • At its latest policymaking meeting, the Federal Open Market Committee (FOMC) maintained its target range for the federal funds rate, as expected. The range is still 2.25% to 2.5%.

  • The Fed’s statement highlighted both strengths of the economy as well as challenges it faces. Specifically, both headline and core inflation continue to trend lower.

  • In a strictly technical move, the Fed lowered the interest rate paid on excess reserves.

As expected, the Federal Open Market Committee—the Federal Reserve’s policymaking arm—on Wednesday maintained the 2.25%-to-2.5% target range for the federal funds rate.1 The decision was unanimous. While the main policy rate was left unchanged, the committee lowered the rate of interest paid on excess reserves.

The FOMC statement highlighted strengths of the economy as well as some challenges it’s facing. However, in his press conference, Fed Chair Jerome Powell struck a modestly more upbeat tone. Once again, the statement reiterated that the committee will be patient as it determines what the next policy move will be.

The market reaction was mixed. Bond yields initially fell following the release of the statement, but then reversed course after the press conference began. Likewise, stock prices initially rose but declined after Powell took the podium.

Economic outlook: pros and cons

The statement kicked off with an acknowledgement of both a strong job market and strong economic activity. That’s not too surprising given the strong gross domestic product readings recently, including the better-than-expected annualized growth rate of 3.2% in the first quarter of 2019.

But the statement also highlighted challenges: The growth of household spending and business fixed investment slowed in the first three months of this year, while inflation has continued to run below the Fed’s 2% target. Both headline inflation and core inflation, which excludes volatile food and energy prices, have been declining lately. The Fed’s preferred gauge of inflation, the core Personal Consumption Expenditure (PCE) price index, dropped to 1.6% on a year-over-year basis in March, its lowest reading in 18 months.

In his press conference Powell highlighted that solid fundamentals are supporting the economy and that other major global economies have shown signs of improvement. Regarding inflation, he indicated that there may be transitory factors at work in keeping it low and that the committee expects it to move back up over time.

The patient approach continues

The statement maintained its language that the “Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate to support these outcomes.”2 Accordingly, at the press conference, Powell stated that the committee didn’t see a strong case for a rate move either way.

This meeting only included a statement followed by a press conference; it did not include updated economic or rate projections, which are updated in the second meeting of each quarter. At the March meeting, the median projection pointed to no rate hikes in 2019, and just one hike in 2020. The market isn’t as optimistic, however, and federal funds implied rates still point to a rate cut by the end of this year.

Market reaction

Bond yields initially dropped, likely due to the statement’s acknowledgement that consumer spending and residential fixed investment slowed, and the recent decline in both headline and core inflation. Two-year Treasury yields initially dropped about five basis points (one basis point is 1/100 of a percent) to 2.20%, while the 10-year Treasury yield initially declined by about two basis points. Short-term Treasury yields are more sensitive to FOMC policy than Treasuries with longer maturities.

However, after Powell acknowledged that there are many supporting factors for the economy, Treasury yields of almost all maturities rose to their highest levels of the day. Given Powell’s comments, the market appears to see the likelihood of a rate cut in the near term as less likely.

Meanwhile, stock prices rose modestly following the conclusion of the meeting, but then dropped after the press conference began.

Technical update: cuts to the interest on excess reserves

Although the Fed maintained its benchmark interest rate in the 2.25%-to-2.5% range, it did modestly cut the rate paid on excess reserves to 2.35% from 2.4%. This was a strictly a technical change meant to keep the effective fed funds rate firmly in line with the Committee’s targeted range. The effective federal funds rate has inched higher recently, and at 2.45% is only modestly below the top end of the Fed’s target range and above the midpoint. At the press conference, Powell stressed that this move did not represent a change in monetary policy.

Takeaways for investors

The Fed is likely on hold for the near term, and will take a patient approach to its policy decisions as the year progresses. Although the economy continues to grow and the job market remains strong, most inflation indicators continue to remain below the Fed’s 2% target. A patient approach going forward likely means that Treasury yields likely won’t rise much from their current levels. Historically, Treasury yields of all maturities tend to converge at the Fed’s terminal rate, or the rate at which it stops its rate-hike cycle.

 

¹ The federal funds rate is the interest rate at which depository institutions, such as banks and credit unions, lend reserves overnight to other depository institutions.

2 Board of Governors of the Federal Reserve System, “Federal Reserve Press Release,” May 1, 2019.

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Important Disclosures:

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