Lowering Guidance To 0 Hikes In 2019 - Fed Matches Expectations

Lowering Guidance - Fed Does Exactly What’s Expected

Fed did exactly what I expected. It didn’t raise rates, lowered guidance to no hikes this year, and gave clarification on the balance sheet unwind.

Fed plans to shrink the unwind from $30 billion per month to $15 billion from May to September. Then end the unwind at the end of September. Fed’s balance sheet will end QT at about $3.8 trillion.

I will review the changes to the Fed’s statement to clarify the Fed’s dovish change. To be clear, the Fed went from projecting 2 hikes this year to projecting 0 hikes.

Futures market has been predicting no hikes for weeks. Yet the Fed’s last guidance was in December. Thus making it look like the Fed is far behind the curve. Personally, I don’t think the Fed is behind the curve.

Inflation is low and economic growth has slowed, especially internationally.

Lowering Guidance - There’s no reason to hike rates if inflation is under 2%.

There’s no reason to cut rates because the economy doesn’t show many recessionary warning signs.

Those who say the Fed is behind the curve believe it needs to act on projections that aren’t fully supported. If you see growth accelerating, then you might think the Fed should be hiking rates.

If you think the economy is going into a recession, you think the Fed should be cutting rates. It’s fine to have those projections if you’re an investor. But the Fed can’t act unless there is more evidence of either forecast.

Lowering Guidance - Just because the curve is flattening doesn’t mean the Fed made a mistake.

This curve has been flattening since the difference between the 10 year yield and the 2 year yield peaked at 2.91% in February 2011. Since then, the labor market has created millions of jobs and real wage growth has mostly been positive.

Fed is now left with a strong labor market, low inflation, and an expansion that is about to be the longest since the 1800s. Based on the improvement in the yearly growth rate in the ECRI leading index, I wouldn’t cut rates if I controlled the Fed. Economic growth should be weak in the first half of the year and improve in Q4.

Lowering Guidance - Changes To The Fed’s Statement

At the beginning of the statement, the Fed wrote, “the labor market remains strong” instead of saying it “continued to strengthen.” That dovish change was catalyzed by the weak February jobs report.

It showed the economy only added 20,000 jobs. That was probably a one-off weak report, but we won’t know until it is revised and the March report comes out in about 2 weeks.

Next change was in the same sentence. Fed went from saying “that economic activity has been rising at a solid rate” to stating, “growth of economic activity has slowed from its solid rate in the 4th quarter.” In terms of GDP growth, this is an accurate assessment. GDP growth was 2.6% in Q4 and the median estimate is for 1.4% Q1 GDP growth. It’s very clear, Q1 economic growth will below the long term trend.

Fed goes on to say, payroll employment was “little changed” and that job gains have gone from “strong” to “solid.” Job creation was minimal in February, but the 3 month average of job creation was still solid because of the 311,000 jobs added in January.

The Fed is correct to focus on this average because the BLS reports are volatile.

Lowering Guidance - Consumer Spending Might Be Better Than The Fed Expects

Then the Fed stated, “recent indicators point to slower growth of household spending” which is different from the last statement where it wrote, “household spending has continued to grow strongly.”

This change is in response to the weak December and January retail sales reports and the relatively weak housing market. I think the consumer will regain strength in the next few months because real wage growth is strong.

Latest Redbook same store sales report showed yearly growth in the week of March 16th increased to 4.9% from 4.4% last week. That’s a 0.7% improvement from the 8 month low 2 weeks ago.

Lowering Guidance - Business Investment Growth Falling

In January, the Fed stated, “growth of business fixed investment has moderated from its rapid pace earlier in the year.” In Q2 2018, business fixed investment growth peaked.

Investors initially thought business fixed investment growth would be weak in 2019. Fiscal stimulus’ effects would wear off. I have since seen analysis which shows the fiscal stimulus will help the economy in 2019 more than last year.

Either way, the recent weakness pushed the Fed to state there were indicators that pointed to slower growth in business fixed investment just like household spending.

Finally, on inflation the Fed stated, headline inflation fell mainly because of lower energy prices. Market based measures of inflation “remained low” instead of “moved lower.” Fed is simply stating the changes to PCE, core PCE, and TIPS.

Lowering Guidance - Small Guidance Changes Don’t Add Up To No Hikes

The table below shows the changes to the Fed’s projections for real GDP, the unemployment rate, PCE, and core PCE. Considering the small changes to these estimates, you wouldn’t expect forward interest rate guidance to be that different, but it is.

Specifically, the 2019 GDP estimate fell 0.2% to 2.1% which is still above the longer run estimate. The estimate for the 2019 unemployment rate increased 0.2% to 3.7% which is still below the longer run rate of 4.3%. Headline PCE inflation is expected to be 1.8% instead of 1.9%. Those are such small changes, making it weird to see 2 less rate hikes in 2019.

One possible justification for these hikes is that you could say the stock market would have crashed without the Fed’s open mouth policy change in late December.

These estimate changes are slight because the Fed knows its dovishness is helping the economy. The Fed is finally officially caught up with the changes it made in December.

It’s interesting to see that longer run estimate of the Fed funds rate stayed at 2.8%. So, rates won’t get above the longer run rate this cycle. Rates are projected to peak at 2.6% instead of 3.1%.

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