No Change in Fed Interest Rate, But Plenty of Surprises

The Fed Open Market Committee (FOMC) held its first policy meeting of 2019 this week, and Fed Chairman Jerome “Jay” Powell held a press conference afterward. As I have written earlier this month, the Fed has significantly changed its position on interest rates since late last year. As recently as December, the Fed was indicating it would probably raise interest rates three times this year.

Yet as I have written in the last few weeks, the Fed has been dropping hints that it has softened its view on rate hikes, using carefully chosen words like “patient” and “wait and watch.”  Well, yesterday the Fed made it official. There may be only one or zero Fed Funds rate hikes this year. What a switch!

In his press conference after the Fed policy meeting yesterday, Mr. Powell said, “The case for raising rates has weakened somewhat.” Asked if the next move would be up or down, Mr. Powell said it would depend on incoming data. The Fed previously had a strong inclination to raise rates.

Chairman Powell indicated yesterday that the US economy is in a good place (solid growth). However, the Fed is concerned that financial conditions have tightened, global growth is slowing and the outcome of ongoing trade disputes (China) remains uncertain, as does the outcome of Brexit.

In his news conference, Powell noted that because inflation remains low, this gives the FOMC the latitude to see how these various issues can be resolved before deciding on the appropriate path of the Fed Funds rate going forward.  This is a big change, and I think it makes sense.

Most Fed-watchers took that to mean the Fed won’t hike rates in the first half of this year. Then Powell went a step further and hinted that if some of these outstanding issues are resolved, and if the economy remains in a good place, the Fed might not have to do anything this year. Wow, what a change!

The other bombshell yesterday was the FOMC’s new policy on the rate of unwinding its huge balance sheet. On this issue, the Fed introduced another new buzzword – “flexible”  on how fast it will continue to unwind its balance sheet.

While the Fed has been allowing apprx. $50 billion a month in Treasury securities to mature and roll off the books, Powell said the Fed could be flexible and reduce the rate of the unwind as necessary. He even hinted that it could go to zero if need be.

You may recall that the Fed increased its balance sheet, which includes US Treasuries and mortgage-backed securities, to a record $4.5 trillion in 2008 to help pull the economy out of the recession. From that peak, the balance sheet has been reduced by an estimated $500 billion.

No one has been certain about how much the Fed intends to reduce its balance sheet. In yesterday’s press conference, Powell said the Fed intends to maintain “ample reserves” on an ongoing basis. Most Fed-watchers took that to mean that the Fed may halt the monthly wind-down before too long, to perhaps somewhere north of $3 trillion.

So what does this change in Fed policy mean for investors? For starters, the more dovish shift at the Fed should be bullish for stocks. It removes, at least for now, the threat of higher interest rates just ahead. That could change, of course, depending on upcoming economic data.

The Dow Jones rallied over 400 points on the news Wednesday, so the stock markets welcomed the change in Fed policy. The Dow closed above 25,000 for the first time in weeks. As always, we’ll have to see if that lasts. My guess is it will.

In closing, let me remind you of something I wrote in December where I pointed out that the Fed usually follows the wishes of US presidents when it comes to setting monetary policy. In the latter months of 2018, the Fed was unwavering that interest rates needed to move higher.

Yet President Trump was adamant that the Fed was wrong. He openly criticized the Fed, and his own choice of Jerome Powell as Fed Chairman, for its hawkish view of interest rate policy. Once again, we now see how the Fed often comes around to the president’s way of thinking.

Just to be clear, I’m not saying the Fed is wrong in its latest policy shift. In fact, I actually agree with it. The point is, the supposedly independent Fed has a long history of coming around to the president’s wishes.

That’s a long discussion I’ll leave for another day.

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