No hikes expected in 2019
The Fed revised down its growth forecasts modestly for 2019 and 2020, reflecting the recent loss of economic momentum as well as its own shift in rhetoric. The path of unemployment has also been revised up, with the unemployment rate expected to rise over the forecast period.
The updated ‘dots’ plot reinforces the dovish stance, with no more hikes expected in 2019 and only one in 2020. This is still more than the market is pricing in; no Federal Open Market Committee (FOMC) participant expects a rate cut over the forecast horizon. In addition, the FOMC announced that balance sheet runoff will end in September, earlier than overall market expectations. Chairman Powell emphasised that the economic outlook remains favourable, with the main risks being external, including the global slowdown, trade uncertainty and Brexit. At the same time, the FOMC believes that current data does not point to a policy move in either direction, reinforcing the need to be patient.
Little room to move
While these changes solidify the outlook for a continued pause in the tightening cycle, they do not leave the Fed with much room to manoeuvre should data surprise on the upside as the year unfolds. The dovish pivot may soon come back to bite them. Given first-quarter data distortions which bias activity data to the downside, it will take a bit longer for better clarity on economic momentum to emerge.
We are likely to see a bounce in activity indicators through the second quarter, pointing to some acceleration after the disappointing start to the year. The combination of easier financial conditions, continued tightening in the labour market and some improvement in growth and inflation later this year could necessitate another policy pivot, putting the Fed back on the policy normalisation trajectory. Resumption of the hiking cycle - either towards the end of this year or in 2020 - remains my base case for now. Given current pricing, markets would be vulnerable in that scenario. In the meantime, with the ‘Powell put’ firmly in place, we seem to be back in full risk-on mode.
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