As a clear sign of the Fed's concern over the dampening impact on the U.S. economy from slowing global growth, the Federal Open Market Committee (FOMC), the Fed's policy-making arm, said it was prepared to adjust the pace of the normalization of its balance sheet and use this "if future economic conditions were to warrant a more accommodative monetary policy than can be achieved solely by reducing the federal funds rate."
Underlining this marked shift to a more dovish stance, which was first signaled by Fed Chairman Jerome Powell on Jan. 4, the FOMC also dropped its previous reference to the need for further gradual increases in the federal funds rate.
In December, when the Fed raised its rate for the 9th time since December 2015, the Fed cut its forecast for rate hikes this year to two from an earlier forecast of three as it said it was now taking into account financial and international developments, a reference to the stock market sell-off in December and the weakening pace of global growth.
In today's statement, which was unanimously adopted by the FOMC's 10 members, the Fed reiterated its view from December that the labour market had continued to strengthen, that economic activity has been rising at a solid rate, job gains have been strong, household spending has continued to grow strongly while the growth of business investment has moderated.
But instead of its past reference to the need for further increases in the fed funds rate to maintain the economic expansion and inflation near its objective, the FOMC today merely said it viewed a "sustained expansion of economic activity, strong labour market conditions and inflation near the Committee's symmetric 2 percent objective as the most likely outcomes."
"The case for raising rates has weakened somewhat," Powell said, adding inflation has been muted in past months and the recent drop in oil prices is likely to push inflation lower in coming months.
In a slight change to its comment on inflation, the FOMC added today that "measures of inflation compensation have moved lower in recent months" but reiterated that overall and core inflation remain near 2 percent and measures of longer-term inflation expectations were little changed."The case for raising rates has weakened somewhat," Powell said, adding inflation has been muted in past months and the recent drop in oil prices is likely to push inflation lower in coming months.
In addition, the Fed omitted its previous reference to the risks to its economic outlook as "balanced," a further illustration of the uncertainty about its future policy.
In a separate statement, the FOMC also confirmed its longer-run goals and monetary policy strategy, which includes the target of 2.0 percent inflation, as measured by the annual change in personal consumption expenditures, and its commitment to living up to its mandate from the U.S. Congress of "promoting maximum employment, stable prices and moderate long-term interest rates."
In the statement, which was originally adopted in 2012, the FOMC also referred to its estimate of the longer-run unemployment rate, which in its most recent projections was 4.4 percent.
Headline inflation in the U.S. dropped to 1.9 percent in December from 2.2 percent in November while growth in the third quarter eased to 3.4 percent from the second quarter.
The U.S. dollar weakened around 0.6 percent in the wake of the Fed's policy shift to trade at 1.148 to the euro.
The Board of Governors of the Federal Reserve System released three statements: The FOMC statement, a statement about balance sheet normalization the transcript of Chairman Jerome Powell's opening remarks to the press conference
FOMC STATEMENT:
"Information received since the Federal Open Market Committee met in December indicates that the labor market has continued to strengthen and that economic activity has been rising at a solid rate. Job gains have been strong, on average, in recent months, and the unemployment rate has remained low. Household spending has continued to grow strongly, while growth of business fixed investment has moderated from its rapid pace earlier last year. On a 12-month basis, both overall inflation and inflation for items other than food and energy remain near 2 percent. Although market-based measures of inflation compensation have moved lower in recent months, survey-based measures of longer-term inflation expectations are little changed.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. In support of these goals, the Committee decided to maintain the target range for the federal funds rate at 2-1/4 to 2-1/2 percent. The Committee continues to view sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee's symmetric 2 percent objective as the most likely outcomes. In light of global economic and financial developments and muted inflation pressures, 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.
In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its maximum employment objective and its symmetric 2 percent inflation objective. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.
Voting for the FOMC monetary policy action were: Jerome H. Powell, Chairman; John C. Williams, Vice Chairman; Michelle W. Bowman; Lael Brainard; James Bullard; Richard H. Clarida; Charles L. Evans; Esther L. George; Randal K. Quarles; and Eric S. Rosengren."
STATEMENT ABOUT MONETARY POLICY IMPLEMENTATION AND BALANCE SHEET NORMALIZATION:
"After extensive deliberations and thorough review of experience to date, the Committee judges that it is appropriate at this time to provide additional information regarding its plans to implement monetary policy over the longer run. Additionally, the Committee is revising its earlier guidance regarding the conditions under which it could adjust the details of its balance sheet normalization program. Accordingly, all participants agreed to the following:
"After extensive deliberations and thorough review of experience to date, the Committee judges that it is appropriate at this time to provide additional information regarding its plans to implement monetary policy over the longer run. Additionally, the Committee is revising its earlier guidance regarding the conditions under which it could adjust the details of its balance sheet normalization program. Accordingly, all participants agreed to the following:
- The Committee intends to continue to implement monetary policy in a regime in which an ample supply of reserves ensures that control over the level of the federal funds rate and other short-term interest rates is exercised primarily through the setting of the Federal Reserve's administered rates, and in which active management of the supply of reserves is not required.
- The Committee continues to view changes in the target range for the federal funds rate as its primary means of adjusting the stance of monetary policy. The Committee is prepared to adjust any of the details for completing balance sheet normalization in light of economic and financial developments. Moreover, the Committee would be prepared to use its full range of tools, including altering the size and composition of its balance sheet, if future economic conditions were to warrant a more accommodative monetary policy than can be achieved solely by reducing the federal funds rate."CHAIRMAN POWELL'S OPENING REMARKS TO THE PRESS CONFERENCE:
CHAIRMAN POWELL: Good afternoon, everyone, and welcome. I will start with a recap of our discussions, including our assessment of the outlook for the economy, and the judgments we made about our interest rate policy and our balance sheet. I will cover the decisions we made today, as well as our ongoing discussions of matters on which we expect to make decisions in coming meetings. My colleagues and I have one overarching goal: to sustain the economic expansion, with a strong job market and stable prices, for the benefit of the American people. The U.S. economy is in a good place, and we will continue to use our monetary policy tools to help keep it there. The jobs picture continues to be strong, with the unemployment rate near historic lows and with stronger wage gains. Inflation remains near our 2 percent goal. We continue to expect that the American economy will grow at a solid pace in 2019, although likely slower than the very strong pace of 2018. We believe that our current policy stance is appropriate at this time.
Despite this positive outlook, over the past few months we have seen some cross-currents and conflicting signals about the outlook. Growth has slowed in some major foreign economies, particularly China and Europe. There is elevated uncertainty around several unresolved government policy issues, including Brexit, ongoing trade negotiations, and the effects from the partial government shutdown in the United States. Financial conditions tightened considerably late in 2018, and remain less supportive of growth than they were earlier in 2018. And, while most of the incoming domestic economic data have been solid, some surveys of business and consumer sentiment have moved lower, giving reason for caution.
We always emphasize that our policies are data dependent. In other words, as economic
conditions and the outlook evolve, we take that new information into account in setting our policies. We are now facing a somewhat contradictory picture of generally strong U.S. macroeconomic performance, alongside growing evidence of cross-currents. At such times, common sense risk management suggests patiently awaiting greater clarity--an approach that has served policymakers well in the past. With that in mind, I’d like to spell out how the Federal Open Market Committee (FOMC) has been thinking about these issues.
At our December meeting, we noted the solid outlook for steady growth, vigorous job creation, and price stability. We also stressed that the extent and timing of any rate increases were uncertain, and would depend on incoming data and the evolving outlook. We therefore said that we would be paying close attention to global economic and financial developments and assessing their implications for the economic outlook.
Today, the FOMC decided that the cumulative effects of those developments over the last several months warrant a patient, wait-and-see approach regarding future policy changes. In particular, our statement today says, “In light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate.”
This change was not driven by a major shift in the baseline outlook for the economy. Like many forecasters, we still see “sustained expansion of economic activity, strong labor market conditions, and inflation near ... 2 percent” as the likeliest case. But the cross-currents I mentioned suggest the risk of a less-favorable outlook.
In addition, the case for raising rates has weakened somewhat. The traditional case for rate increases is to protect the economy from risks that arise when rates are too low for too long, particularly the risk of too-high inflation. Over the past few months, that risk appears to have diminished. Inflation readings have been muted, and the recent drop in oil prices is likely to push headline inflation lower still in coming months. Further, as we noted in our post-meeting statement, while survey-based measures of inflation expectations have been stable, financial market measures of inflation compensation have moved lower. Similarly, the risk of financial imbalances appears to have receded, as a number of indicators that showed elevated levels of financial risk appetite last fall have moved closer to historical norms.
In this environment, we believe we can best support the economy by being patient in evaluating the outlook before making any future adjustment to policy.
Let me now turn to balance sheet normalization. Over its past three meetings, the FOMC has held in-depth discussions on the final stages of this process. Today, we made some important progress in clarifying the path forward, as summarized in the Statement Regarding Monetary Policy Implementation and Balance Sheet Normalization that we released with today’s FOMC statement.
The Committee made the fundamental decision today to continue indefinitely using our current operating procedure for implementing monetary policy. That is, we will continue to use our administered rates to control the policy rate, with an ample supply of reserves so that active management of reserves is not required. This is often called a “floor system” or an “abundant reserves system.” Under the current set of operating procedures, as outlined in the implementation note released today, this means that the federal funds rate, our active policy tool, is held within its target range by appropriately setting the Federal Reserve’s administered rates of interest on reserves, as well as the offer rate on the overnight reverse repo facility, without managing the supply of reserves actively. As the minutes of our recent discussions have indicated, the FOMC strongly believes that this approach provides good control of short-term money market rates in a variety of market conditions and effective transmission of those rates to broader financial conditions.
Settling this central question clears the way for the FOMC to address a number of further questions regarding the remaining stages of balance sheet normalization. The decision to retain our current operating procedure means that, after allowing for currency in circulation, the ultimate size of our balance sheet will be driven principally by financial institutions’ demand for reserves, plus a buffer so that fluctuations in reserve demand do not require us to make frequent sizable market interventions. Estimates of the level of reserve demand are quite uncertain, but we know that this demand in the post-crisis environment is far larger than before. Higher reserve holdings are an important part of the stronger liquidity position that financial institutions must now hold. Moreover, based on surveys and market intelligence, current estimates of reserve demand are considerably higher than estimates of a year or so ago. The implication is that the normalization of the size of the portfolio will be completed sooner, and with a larger balance sheet, than in previous estimates.
In light of these estimates and the substantial progress we have made in reducing reserves, the Committee is now evaluating the appropriate timing for the end of balance sheet runoff. This decision will likely be part of a plan for gradually reaching our ultimate balance sheet goals while minimizing risks to achieving our dual mandate objectives and avoiding unnecessary market disruption. We will be finalizing these plans at coming meetings.
The process of balance sheet normalization is unprecedented. Throughout this process we’ve attempted to lay out our plans well in advance, and we’ve been willing to make changes as we learn more about the process. The implementation and normalization statement released today is intended to provide some additional clarity regarding the conditions under which we might adjust our plans. The statement makes three points:
First, as we’ve long emphasized, the federal funds rate is our active monetary policy tool. Second, as far as the particular details of normalization are concerned, we will not hesitate to make changes in light of economic and financial developments. This does not mean that we would use the balance sheet as an active tool, but occasional changes could be warranted.
Third, we repeat a sentence of the normalization principles we adopted in June 2017. While the federal funds rate would remain our active tool of policy in a wide range of scenarios, we recognize that the economy could again present conditions in which federal funds rate policy is not sufficient. In those cases, the FOMC would be prepared to use its full range of tools, including balance sheet policy.
Times of economic uncertainty put a premium on the clarity and predictability of FOMC policy. We are committed to clearly explaining what we are doing and why we are doing it, both regarding the path of rates and also regarding management of the balance sheet. We believe that this transparency is how we can best contribute to macroeconomic stability.
Thank you. I would be glad to take your questions."
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