10 Juli 2018, 14:03 GMT
The Federal Reserve concluded its March monetary policy meeting on Wednesday and, as widely expected, raised interest rates by 0.25%.
This was a meeting fraught with communication risk as the new Fed chair, Jerome H. ‘Jay’ Powell, hosted his first press conference and the Fed provided its widely debated new economic projections.
In fact, what interested me was the contrast between bullish published projections and Powell’s cooler spoken comments.
The Fed’s economic projections are distinctly more bullish. GDP is now expected to be 2.7% in 2018 and 2.4% in 2019, both revised up meaningfully from the Fed’s last projection in December. Similarly, unemployment was projected to be lower than it was in December, now falling to 3.6% in 2018.
As a consequence, the Fed participants’ projections of interest rates have risen. Some commentators will say that the median projection has hardly changed. It’s true that the median interest rate projection by end of 2018 is still 2.1% and for 2019 it’s risen slightly from 2.7% to 2.9%. But it’s the new range that’s more interesting. In December, four of 15 participants expected the end of 2018 interest rate to be less than 1.9% and only four expected a rate higher than 2.3%. Now, all bar one member expects 2.1% or higher. The Fed is definitely now thinking of four benchmark rate increases this year.
Incidentally the suspected rise in the Fed’s estimate of normal interest rates didn’t materialise - that rate sits at 2.9% (up only 0.1% from December). For what it’s worth, Fidelity International’s estimate is 3.25%.
In his prepared remarks, Powell was almost egregious in his use of the word ‘gradual’ in stating the Federal Open Market Committee’s intent for policy from here. That’s a clear message that his Fed policy is very much a continuation of Janet Yellen’s Fed.
Whilst Powell is not the economist Yellen was, he did well in the journalist Q&A, being surprisingly direct with his answers. He felt we were not on the cusp of increased inflation and thus the Fed could continue on its course of gradual rises. He expressed surprise that wages haven’t risen more but observed this may not happen until productivity improves.
Powell noted that the Fed considers fiscal reform as a significant driver of increased demand over the next 3 years, but trade policy issues won’t affect its current economic outlook. However, there was much uncertainty on the impact of these issues.
Powell was asked if he thought an asset bubble was present, to which he said he felt some equities were expensive, as was commercial real estate, but that housing was not, and this was a comfort to the Fed. He added that the banking system appeared to be stable.
All told, Powell came across as more cautious than the monetary policy statement and projections implied. It’s tough to say whether the total package was hawkish or not - probably marginally so.
As the US economy continues to improve, the Fed still desires to normalise rates. I believe inflation won’t increase enough to warrant all these aspired rate rises for 2018 and 2019. Therefore, as we nudge ever closer to a 3% 10-year Treasury bond yield, I’m a buyer.
I’m cautious of expressing monetary policy opinions through the US dollar, because it seems as if there is a potential for the market to return to the twin deficits (budget deficit and current account deficit) as a driver of the currency. Nonetheless, in a world of yield-reaching, the fact that the US-Europe cash differential now exceeds 2% is appealing. Like a moth to the light, I’m drawn to that. It’s not that I expect dollar appreciation, but I don’t foresee meaningful depreciation until the twin deficits are closer to the centre stage.
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