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Federal Reserve, Data Dependency & Projection Materials

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Federal Reserve Policy: Circumspect in all things
The Federal Open Market Committee (FOMC) raised the Fed Funds rate 25 basis points  to 2.5% at the December 19th meeting. It was the fourth increase of the year and the highest base rate since March 2008.

The bank reduced by one the number of projected increases next year. The new 2.9% Fed Funds estimate for December 2019 needs only two to get there from 2.5%. It also reduced the terminal rate in 2020 and 2021 to 3.1% from 3.4%, keeping one incease in 2020.  The bank also dropped its 2018 GDP projection to 3% from 3.1% and its 2019 forecast to 2.3% from 2.5% while keeping 2020 at 2% and 2021 at 1.8%. 

The US central bank began this rate cycle in December 2015 having kept the Fed Funds upper target rate at 0.25% for seven years in the aftermath of the financial crisis.  The governors hiked just once in 2016, delayed by the sharp equity fall in the first two months of the year and worried about the strength of the recovery, three times in 2017 and four this year. 

The US economy is performing well and with inflation just below the Fed's 2% target there has been considerable public discussion about the terminus or neutral rate for Fed policy.  This is the level at which interest rates neither encourage nor inhibit economic activity. The rate is presumed to be between 2.5% and 3.25%, the upper end of the current rate projections.  Fed Chairman Powell said as much when he stated that the Fed Funds (then 2.25%) were just below the neutral level.  Mr. Powell also stated that the bank has become more 'data dependent' as it approaches the end of its tightening cycle. 

Data Dependency
'Data dependent' means taking your cues from the economy. But it also means adressing threats to the economy as they appear.  December's FOMC did both. The healthy US economy let the Fed add one more 0.25% increase to its normalization total. The "Projection Materials"  temporized on the future, reducing September's three 2019 inceases to two while leaving one in 2020 and none in 2021.  

Although the US economy seems to be bearing higher rates well the Fed is clearly taking out an insurance policy on the future and the global economy.

If the US begins to slow next year will it be due to the cumulative effect of higher US interest rates or from the gathering drag from the global decline in economic growth? Will the trade dispute with China or a Brexit recession in Europe bring US  GDP to the Fed's projected 2.3% in 2019?

A further consideration for the bank governors is the sharp equity sell off in the past ten weeks. The major US average are all now down for the year though even with the recent decline US equities remain more than 20% higher since the 2016 election.

The Fed’s newly asserted data dependency is reinforced by the additional press conferences in 2019. Instead of the usual four after the FOMC meeting scheduled with ecoonomic projections, Chairman Powell will make a statement and take questions after all eight meetings.

The Fed clearly feels that rates are approaching an inflection point, the neutral rate and intends to keep its public stance more current. As that point nears it paradoxically makes the Fed ‘dot plot’ of rate projections less important. The Chairman’s comments will overtake any intention gleaned from the older information.

One interesting note on the Fed Funds rate is that in its relation to inflation it is essentially zero. The Fed Funds rate is 2.5% and CPI in November was 2.2%.   

Projection Materials
At the September release the estimates for US economic growth were 3.1% in 2018, 2.5% in 2019, 2.0% in 2020, and 1.8% in 2021 and in the ‘longer run’, as the bank phrases it.  As of the December FOMC the estimates are 3.0% in 2018, 2.3% in 2019, 2.0% in 2020 and 1.8% in 2021. The 'longer run gets 1.9%. 

Annualized GDP is currently running at 3.125%, taking the Atlanta Fed’s 2.7% current estimate for the fourth quarter.

The key to the projections is their change over time.  Until the December materials the estimates for US growth had been rising. The September GDP figures were higher than the June numbers which were 2.8% for 2018 and 2.4% in 2019. The later years were unchanged,

Although the economic prospects improved from June to September the rate projections did not change that month except in the imprecise ‘longer run’ category beyond 2021.

In the September materials the Fed Funds rate was projected at 2.4% at the end of this year which was achieved with the hike on Wednesday. They were projected at 3.1% in December 2019, 3.4% in 2020 and 2021.  The December materials now posit 2.9% at the end of 2019, and 3.1% in 2020 and 2021. This implies two 0.25% hikes next year and one in the two years after. 


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