The Federal Reserve left short-term interest rates on hold.
The Fed sees moderate growth, but little inflation pressure.
Balance sheet growth likely will end in Q2.
As expected, the Federal Open Market Committee (FOMC)—the Federal Reserve’s policymaking arm—left the federal funds rate target in a range of 1.5% to 1.75%.
The post-meeting statement, which generally provides an overview of economic conditions, was mostly unchanged from last month’s statement. It characterized the economy’s growth rate as “moderate” and noted that job gains and consumer spending have been solid, while business investment and exports have been weak.
On the topic of risks, the Fed Chair Jerome Powell indicated that easing trade tensions between the U.S. and China were positive, and said the central bank was monitoring the spread of the coronavirus in China in case it could cause global economic growth to slow. The spread of the virus has already caused a decline in business activity in China, and has the potential to disrupt company supply chains and slow both output and demand.
Despite the relatively positive view of the domestic economy, the Fed remains concerned about the stubbornly low level of inflation. The Fed’s preferred gauge of inflation, the core Personal Consumption Expenditures (PCE) Index, is running at a 1.6% annual rate, well below the Fed’s 2% target, and has been below that target for most of the past decade, despite the very low level of interest rates.
Based on Powell’s upbeat assessment of the state of the economy, we believe the Fed is likely to keep rates on hold through the first half of the year. Unless there is material deterioration in the global economic outlook, the Fed appears satisfied that the policy rate is appropriate. However, while this meeting did not include updated quarterly economic projections or a “,” the market is anticipating a high likelihood of another cut in the federal funds rate by the end of the year. However, we don’t expect a change in policy unless economic conditions weaken significantly.
The balance sheet
There was a lot of attention paid to the balance sheet during Powell’s press conference. The Fed has been purchasing about $60 billion in Treasury bills per month in order to provide liquidity to the short-term funding markets (often called the repurchase agreement, or repo, market). The Fed indicated that purchases will continue through April, when tax season usually raises the demand for funds, but that the size of the purchases likely will diminish and end when the level of reserves is large enough to stabilize the market. The Fed’s intention is to raise the level of reserves to a point that makes it possible to keep the federal funds rate in its target range.
The purchases have expanded the Fed’s balance sheet, giving rise to the theory that it’s a form of quantitative easing. Powell reiterated that the Fed’s recent T-bill purchases are not the same as quantitative easing, because they don’t involve buying long-term bonds and don’t expand the availability of credit to the financial system. Powell reiterated that the measures taken in the repo market are not the same as quantitative easing.
No statement on long-term monetary policy goals
The Fed usually releases its annual statement on long-term monetary policy goals at the first meeting each year. However, since the Fed is in the middle of reviewing its policies, the statement has been postponed. There is some speculation that the Fed might address its problem with raising inflation by setting a higher inflation target. However, it isn’t clear how the Fed would achieve that goal.
After the Fed announcement, short and long-term bonds rallied, pushing yields lower, while stocks rallied modestly. However, we see little new in this announcement outside of the more explicit timing of the end of T-bill purchases.
Takeaways for investors
The Fed left short-term interest rates unchanged at its meeting. While concerns about global growth and low inflation make it more likely that the next rate move by the Fed will be a cut, we don’t expect any change in the near term as long as the U.S. economy remains resilient.
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